Corporation Taxes in the EU New Member States and the Location of Capital and Profit

1. Corporation Taxes in the EU New Member States and the Location of Capital and Profit Michael P. Devereux University of Warwick

2. 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

3. 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

7. 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

8. Policy: Aims • Maintain minimal distortions to economic decisions within the economy • Maintain an attractive location for investment • Prevent excessive outward shifting of taxable profit

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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