International competition versus co-ordination in corporate taxation: The dilemma for the European Union

In recent years, reductions in institutional barriers to international investment and in non-tax costs of transferring capital have left the existence of international corporate tax differentials as one of the most significant remaining causes of distortion to the optimum global allocation of resources. In the debate as to how to reduce this distortion, two main schools of thought have emerged. The first contends that market forces, or “tax competition”, will spontaneously eliminate international corporate tax differentials. The second believes that these differentials can be eradicated only through international coordination of corporate taxes. The debate is currently most intense in the European Union, where the existence of tax differentials threatens the achievement of the Union’s expressed objectives. However, in a fast-integrating world economy, the lessons being learnt from the EU experience may be valuable in a wider geographical context. This article considers the comparative merits of these two approaches. Four criteria are employed: the size of the public sector and the efficient provision of public goods, problems in negotiating, obtaining and implementing international agreement, the inclusiveness of any agreement, and the effectiveness of eliminating economic distortions. The article also considers other factors that may influence the choice of approach. Future demographic changes and a natural bias in government circles may favour coordination. However, unanimity is required to pass all EU proposals involving taxation, making significant progress difficult. The inherent limitations of both approaches may mean that the strategy of targeting the more overt forms of tax-induced investment distortion, while avoiding a direct assault upon international differentials in tax levels, may, at least in the near future, be the most expeditious way of proceeding. Classification Codes: H25 Business Taxes, F02 International Economic Order