Harmful corporate tax competition has become a global phenomenon 3 . Differences in corporate taxation between countries are the driving force for corporate profit shifting.
The Single Market offers unique advantages to citizens and businesses. It has increased welfare by lowering prices and increasing choices. It has helped businesses to access larger markets, tap new sources of finance and allocate their activities according to their economic needs. However, the co-existence of 28 different tax systems in one integrated market has also resulted in strong tax competition between Member States. As a consequence, Member States have progressively lowered their corporate tax rates, in order to protect their tax bases and attract foreign direct investment. Graph 1 shows that the general decrease in statutory tax rates is particularly strong in the euro area and in the EU as whole, where the principles of free movement in the Single Market allow for even greater mobility of tax bases and profits.
Graph 1: Statutory corporate tax rates 1995-2014
As set out in the Annual Growth Survey 2015, broadening tax bases, simplification and enhanced transparency can help increase the efficiency of the tax system and improve tax compliance as well as the fight against aggressive tax planning. 4 Indeed most governments have broadened the tax base to at least partly compensate for the lower rates, but a number of them offer targeted regimes or rulings that provide considerably lower rates for certain types of income or companies. Also, the majority of corporate income tax systems favour debt over equity, by allowing the deductibility of interest payments while not granting similar treatment to equity. This may lead to an excessive reliance on debt by business which could restrain investments.
Even though corporate tax rates have fallen, company taxation continues to be an important source of revenue for every Member State. In 2012, on average 6.5% of tax revenue was collected from corporations in the EU-27 (2.6% of GDP).
Graph 2: CIT in per cent of total tax revenue, EU-27
Despite the stability in corporate revenue, many factors suggest that corporate tax revenues should instead have increased over time. First, policies to broaden the tax base have partly offset the impact of lower rates. Second, incorporation has increased in recent years and this has increased the overall base. Lastly, relatively low interest rates in recent years have limited the interest deductibility from the corporate tax base which has also had a base broadening effect. These effects do not only explain the stability of tax revenues, they indeed raise the question why the share of corporate taxes in total revenue has not increased over time. This may be due to the fact that certain companies pay far less than the statutory tax rate, including by engaging in aggressive tax planning.
To offset the impact of lower corporate tax rates and corporate tax avoidance, some governments have also increased the tax burden on less mobile companies and on labour. This undermines the efficiency and growth-friendliness of their tax systems. The increased tax burden on labour creates disincentives to work and to create employment. The higher tax burden on less mobile companies raises their cost of capital and reduces their capacity to invest. Furthermore, businesses which cannot, or will not, engage in aggressive tax planning also suffer competitive disadvantages compared to those who do. SMEs are particularly affected in this respect.
Beyond revenue considerations, there is a need to consider the macroeconomic implications of the current diversity in Member States' corporate tax systems for a currency union, and how taxation should fit into the deeper economic and financial integration of the Union and the euro area.
Politically, governments are faced with a dual challenge when it comes to corporate taxation. On one hand, there is strong public demand for greater fairness in taxation. On the other hand, Member States are under intense pressure to create corporate tax systems that are attractive to multinational investors and internationally competitive. As a result, countries continue to stretch the boundaries of what is considered to be acceptable in tax competition, despite EU and OECD/G20 attempts to tackle harmful tax regimes.
While fair tax competition is often considered as a means to encourage investor-friendly tax regimes, tax systems must also secure sustainable revenues, in a fair and efficient way. The legitimacy of tax competition is weakening, if such competition is abused for corporate tax avoidance, fragments the Single Market and prevents fair and efficient taxation.
A new approach is therefore needed to ensure that corporate taxation can be growth-friendly, fair and transparent. To this end, the corporate tax framework in the EU needs to be significantly reviewed. There is a strong case for reforming the corporate tax framework in Europe and reviewing how national tax systems interact.
