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Corporation Taxes in the EU New Member States and the Location of Capital and Profit Michael P. Devereux University of Warwick
Evidence • How does corporation tax affect the location of firms, capital and profit? • Developments of corporation tax in the EU 25 since the mid 1990s • Is tax competition important? Where it will it lead? • Policy issues for new member states • Setting the rate and base • EU harmonisation
Effects Of Corporation Tax • Where to invest? • Depends on effective average tax rate • How much to invest? • Depends on effective marginal tax rate • Where to declare profit? • Depends on statutory tax rate Largest effects on location and profit shifting
Tax Competition • Little formal evidence: but finds that tax rates in one country depend on tax rates in others • Most significant effect for statutory rates • Low tax rates in new member states may increase competition • evidence that taxes are a significant factor in determining capital flows to new member states
Policy: Aims • Maintain minimal distortions to economic decisions within the economy • Maintain an attractive location for investment • Prevent excessive outward shifting of taxable profit
Statutory Tax Rate • affects location decisions through effective average tax rate • EATR depends crucially on statutory rate • affects profit shifting directly So: important to keep a competitive corporation tax rate
Tax Base • Many new member states have special incentives • to encourage investment in specific sectors, or regions But: • higher rate needed to raise a given revenue • success depends on policy-makers correctly identifying – and correcting - market failures • may be ruled out by the EU Code of Conduct So: strong argument for a broad base
Estonia’s tax on dividends • Close to a cash flow tax on economic rent • long advocated by economists • although should have a deduction for new equity • Is Estonia a tax haven? No – profit is taxed when distributed to shareholders • but this ruled out by parent-subsidiary directive • The narrower tax base again requires a higher statutory rate
Harmonisation? EU History • History littered with various major proposals for harmonisation • 1962, 1975, 1991 • Unanimity still required • Only minor proposals implemented • eg. Parent-subsidiary directive • Code of Conduct agreed, though not legally binding
Common Consolidated Tax Base • Calculate tax base for whole of EU, instead of for each country • Tax base allocated to countries by a simple formula • Each country applies its own tax rate • Profit shifting within the EU would disappear • Compliance and administration costs reduced – but wait for the details
Conclusions • Taxes do affect cross-border flows of capital and profit • There are significant competitive pressures on governments • Single most significant policy tool is the statutory tax rate – important for location of firms and their profit