Corporate Income Taxes in the EU: An Economic Assessment of the Role of the ECJ

1. Corporate Income Taxes in the EU: An Economic Assessment of the Role of the ECJ Comments by Alan J. Auerbach April 24, 2006

2. Paper’s Thesis • The ECJ is exerting a powerful force on the shape of European systems of direct taxation. • Complete harmonization of tax systems would be one response to the pressures of ECJ decisions, but is unlikely to happen. • Many distortions will continue to exist, and some will get worse, as a result of ECJ rulings.

3. ECJ’s Guiding Principles • Four Freedoms; among the implications: • No discrimination in favor of domestic producers against foreign producers • No discrimination in favor of domestic production against foreign production • Would seem to correspond to correspond to two common norms of international tax analysis:

4. ECJ’s Guiding Principles • No discrimination in favor of domestic producers against foreign producers • Capital Import Neutrality – impose same, source-based tax domestically on all producers • No discrimination in favor of domestic production against foreign production • Capital Export Neutrality – impose same total tax burden on domestic companies, whether operating at home or abroad

5. Implications • Would seem to suggest a tax system with same effective rate of tax on worldwide and domestic profits, meaning • full creditability of foreign taxes • no domestic tax incentives that lower effective tax rate • This might be a step in the right direction • ECJ’s decisions seem only selectively consistent with this perspective

6. Cases • Imputation systems: must credit foreign taxes • Marks & Spencer: should get to deduct foreign losses against parent’s income. • What about deferred gains? Doesn’t this give a lower tax rate to foreign operations? • Don’t territorial systems and FTC limits discriminate against investors in high-tax countries?

7. Cases • Invalidation of tax breaks for domestic research • seems consistent with keeping same effective tax rate on foreign and domestic activities; but • Would the same restrictions apply to direct grant programs? Infrastructure assistance? Presumably not. • the tax system is only one component of international economic competition

8. Cases • Disallowance of “thin capitalization” rules applied only to subsidiaries to foreign parents • would make sense under a system that obeyed CEN, but not if transfer pricing an issue

9. Summary • ECJ decisions can be viewed as individually rational in the context of a non-existent hypothetical system; in present system, not clear whether even in the right direction • As authors suggest, nothing compels achievement of greater harmonization; some stable equilibrium will be achieved, but not clear what that will be