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Relative taxation and competitiveness in the European Union: what the European Union can learn from the United States
Journal of Policy Modeling 24 (2002) 401–410
Relative taxation and competitiveness in the European Union: what the European Union can learn from the United States Dominick Salvatore∗ 1 Red Oak Road, Bronxville, NY 10708, USA Received 5 January 2002; received in revised form 30 January 2002; accepted 1 March 2002
Abstract In recent years, there has been a great deal of discussion and controversy about the need to harmonize taxation in the European Union (EU). High-tax countries such as Germany, France and Italy are demanding the harmonization of taxes in order to establish a level-playing field and thus avoid the loss of foreign direct investments to countries such as Ireland and the United Kingdom, which have much lower corporate and personal income taxes. The paper presents reasons why tax harmonization in the EU countires may be neither feasible nor desirable and concludes that there is much that the EU can learn from the United States in the tax field. © 2002 Society for Policy Modeling. Published by Elsevier Science Inc. All rights reserved. Keywords: Effective tax rate; International competitiveness; Level-playing field; Relative taxation; Statutory tax rate; Tax harmonization
1. Introduction In recent years, there has been a great deal of discussion and controversy about the need to harmonize taxation in the European Union (EU). Even after the wave of recent tax reductions, some countries, such as Germany, France, and Italy, remain high-tax countries. These countries are demanding the harmonization of taxes in ∗
Tel.: +1-914-961-2917; fax: +1-914-771-7791. E-mail address: [email protected] (D. Salvatore).
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order to establish a level-playing field in the EU and, thus avoid the loss of foreign direct investments and, indeed, the migration of some of their firms, entrepreneurs and highly skilled people to countries such as Ireland and the United Kingdom, which have much lower corporate and personal income taxes. In this paper, I will conclude that, although differences in taxation affect international competitiveness, tax harmonization in the EU countries may be neither feasible nor desirable. Here, there is much that the EU can learn from the United States — a country with the most competitive economy in the world and with lower taxes than most EU members — and where there is not even a thought being given to harmonizing taxes among states. Indeed, in the United States, taxation is an important element of interstate competition in attracting investments from other states and from rest of the world. Trying to harmonize taxes across EU countries is neither feasible nor desirable.
2. Relative tax pressure in EU countries Taxation can influence the international competitiveness of a nation in a crucial way. Indeed, EU countries seem to increasingly compete with tax policies. Table 1 shows the relative tax pressure in the EU members in 2000. Column (2) of Table 1 shows that the corporate tax rate ranged from a low of 24% in Ireland to a high Table 1 Relative tax pressure in the EU, US, and Japan in 2000 Country
Corporate tax rate
Income tax rate for individuals
Government spending
Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg The Netherlands Portugal Spain Sweden United Kingdom
34.0 39.0 32.0 29.0 41.7 40.0 40.0 24.0 37.0 33.0 35.0 32.0 35.0 28.0 30.0
32.0 40.0 35.0 27.0 35.0 31.0 15.0 27.0 34.0 11.2 37.5 25.0 25.0 31.0 20.0
51.8 49.6 53.7 45.3 52.6 47.6 43.3 28.9 48.1 37.2 45.2 46.6 40.6 54.9 39.1
Average EU
34.0
28.4
45.6
United States Japan
35.0 30.0
15.0 10.0
28.9 39.3
Source: WEF, 2000–2002.
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of nearly 42% in France, with an average of 34% for the 15-member EU. The corporate tax rate is relatively low in Sweden (28%), Finland (29%), and the United Kingdom (30%) and relatively high in Italy (37%), Belgium (39%), and Germany (40%). These compare with a corporate tax rate of 35% in the United States and 30% in Japan. Thus, if a multinational corporation, European or otherwise, shops around (as it often does) for a lower corporate-tax-rate country in which to set up production and sales facilities, it surely has ample choice within the EU, and it is the loss of such investments that high-corporate-tax countries experience that leads them to demand tax harmonization. Column (3) of Table 1 shows that personal income tax rates also differ widely among EU countries. They were lowest in Luxembourg (11.2%), followed by Greece (with 15%), the United Kingdom (20%), Portugal and Spain (25%), Ireland (27%), Sweden and Germany (31%), Austria (32%), Italy (34%), France (35%), the Netherlands (37.5%), and Belgium (40%), with an average of 28.4% for the 15-member EU in 2000. These rates compare with the very low rate in the United States (15%) and Japan (10%). It is clearly advantageous for highly skilled individuals and entrepreneurs to work and start new economic activities in Luxembourg and the United Kingdom, within Europe, and especially in the United States, outside Europe. Although Japan has the lowest personal income tax rate, it imposes many restrictions on the migration of even highly skilled people and entrepreneurs and on the setting up of new firms as not to provide much attraction for individuals and entrepreneurs to relocate there. Finally, Column (4) of Table 1 shows the level of overall government expenditures as a percentage of GDP in the EU member countries, and in the United States and Japan in 2000. These figures can be used as a general index of total fiscal pressure in the various nations. The values range from a low of 28.9% for Ireland to a high of 54.9% for Sweden, with an average of 45.6% for EU in 2000. Germany has a rate of 43.3%, Italy 48.1%, and France 52.6%, as compared with 28.9% for the United States and 39.3% for Japan. Europe is simply a high-tax-pressure area in relation to the United States and Japan.
3. Statutory and effective corporate tax rates in EU countries The official or statutory tax rates given in Table 1 hide many exceptions, subsidies, and other tax benefits as to make official tax rates highly suspect as the true measure of fiscal pressure in a country. To overcome this problem, the Dutch Finance Ministry commissioned a study to calculate effective corporate tax rates in the various EU countries (Buijink, Janssen, & Schols, 2000). These are shown in Table 2. Column (2) of Table 2 shows the official or statutory average corporate tax rate from 1990 to 1996, and Column (3) shows the corresponding effective rate in the various EU countries (unfortunately, more recent data are not available or easily obtainable). From Columns (2) and (3) of the table we see that effective tax rates differ widely from the statutory rates. The difference is highest for Portugal
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Table 2 Effective tax pressure in the EU: 1990–1996 average Country
Statutory corporate tax rate (%)
Effective corporate tax rate (%)
Difference in effective rate in relation to average
Survey result on tax system in country (1999)a
Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg The Netherlands Portugal Spain Sweden United Kingdom
36.0 40.3 35.8 34.0 34.7 50.1 32.5 21.9 50.5 39.4 35.0 39.3 35.3 28.5 33.4
17.7 21.0 29.4 29.8 32.8 38.5 20.9 13.9 35.3 34.1 31.8 17.2 24.1 27.5 29.0
−9.2 −5.9 2.5 2.9 5.9 11.6 −6.0 −13.0 8.4 7.2 4.9 −9.7 −2.9 0.6 2.1
4.0 2.5 2.7 4.0 2.1 2.3 3.1 4.7 2.2 5.4 4.4 3.3 3.5 2.6 4.3
Average EU
36.5
26.9
–
–
Sources: for corporate tax rate, Buijink et al. (2000); for survey, WEF (2000). a Tax system in your country promotes bus. Competitiveness: 7, strongly agree; 1, strongly disagree.
(22.10), Belgium (19.29), and Austria (18.35) and smallest for Sweden (1.07), France (1.88), and the Netherlands (3.20), for an average difference of 9.59 for the 15-member EU countries. Thus, looking at the statutory rate gives a very distorted picture of relative corporate tax pressure in the various EU countries. Column (4) shows the difference in the effective corporate tax rate in each EU member with respect to the EU average and, thus provides a more appropriate measure of the relative corporate tax pressure in the various nations. The data in Column (4) show that Ireland has the lowest tax pressure with an effective corporate tax rate 13% below the EU average. It is followed by Portugal with an index of −9.7, Austria with −9.2, Greece with −6.0, Belgium with −5.9, and Spain −2.9. All other countries face an effective corporate tax pressure above the EU average, which is 0.6% above the EU average in Sweden, 2.1 in the United Kingdom, 2.5 in Denmark, 2.9 in Finland, 4.9 in the Netherlands, 5.9 in France, 7.2 in Luxembourg, 8.4 in Italy, and 11.6 in Germany. Thus, Germany, Italy, and France have the highest effective corporate tax pressure among EU countries and that explains why these nations are clamoring for tax harmonization. The last column of Table 2 shows the result of a survey conducted by the World Economic Forum (WEF) in 2000 in which a large sample of corporate CEOs in EU countries were asked to rank from 7 (the highest) to 1 (the lowest) the statement: “the tax system in your country promotes business competitiveness.” A survey is, of course, a very subjective measure, but it does indicate the perception of CEOs
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as to how they view the tax system in their country, and it is on these perceptions that they often base their investment decisions. For example, an Italian CEO will look to invest elsewhere (say in Ireland or England) if he or she believes that the tax system in other countries promotes business competitiveness much more than in Italy. The survey result show that the highest score (i.e., the nation where the tax system is perceived to be most supportive of business competitiveness) is Luxembourg with a score of 5.4. It is followed by Ireland (4.7), the Netherlands (4.4), the United Kingdom (4.3), Austria and Finland (4.0), Spain (3.5), Portugal (3.3), Greece (3.1), Denmark (2.7), Sweden (2.6), Belgium (2.5), Germany (2.3), Italy (2.2), and France (2.1), for an average of 3.4 for all EU members. Although the rank correlation between the effective tax rate and the survey results is not very high (32.5%), the survey results do show that German, Italian, and French CEOs perceive their countries to be high corporate-tax-pressure countries, as shown in Column (3) of the table.
4. Relative taxation and the international competitiveness of European Union countries Relative effective taxation affects the international competitiveness of nations. One measure of the overall international competitiveness of nations is calculated by the Institute for Management Development (IMD) in Lausanne, Switzerland. IMD defines international competitiveness as the ability of a country or company to generate more wealth for its people than its competitors in world markets. Four broad factors were used to measure the relative productivity of each nation. These are: (1) economic performance; (2) government efficiency; (3) business efficiency finance; and (4) infrastructure (the extent to which resources and systems are adequate to serve the basic needs of business). IMD used 286 criteria, grouped in the above four categories, to come up with an overall competitiveness of various nations. To be sure, measuring international competitiveness is an ambitious and difficult undertaking and, although useful, it faces a number of serious shortcomings. One is the grouping and measuring of international competitiveness of large and small countries together. It is well known, however, that large and small countries have very different industrial structures and face different competitiveness problems and so the results are difficult to interpret. Another serious shortcoming is that the correlation between the international competitiveness and the real per capita income of different nations does not seem to be very high. For example, the international competitiveness index is higher for Greece than for Italy even though the real per capita income is much higher in the latter than in the former. The question that naturally arises is: if Italy is less internationally competitive and productive than Greece, where is its much higher per capita income and standard of living coming from? In economics, we like to think that productivity determines per capita incomes and the standard of living, and so it is disconcerting to see such
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a blatant variance between expectations and reality. Despite these shortcomings, however, the international competitiveness results presented above do retain some validity because these are the general factors that investors examine in deciding where to invest. Krugman’s (1994) criticism that “international competitiveness is an irrelevant and dangerous concept because nations simply do not compete with each other the way corporations do, and that increases in productivity rather than international competitiveness are all that matter for increasing the standard of living of a nation” is not really valid. It is true that a country’s future prosperity depends on its growth in productivity, but this can certainly be influenced by government policies. Nations compete in the sense that they choose policies that promote productivity. As pointed out by Dunning (1995) and Porter (1990), and Salvatore (1993, 1998, 2001), international competitiveness does matter. Column (2) of Table 3 shows the international competitiveness index calculated by IMD (2001) for the 15 EU nations in 2001. As the most competitive among the 15-member EU nations, Finland is assigned an index of 100. Luxembourg is second with an index of 99.3. This means that, according to this index, Luxembourg is about 0.7% less internationally competitive than Finland. The Netherlands is third with an index of 97.7 and Ireland is fourth with an index of 95.0. They are followed by Sweden (93.4), Germany (88.7), Austria (86.9), Denmark (86.2), Belgium (79.1), the United Kingdom (77.6), Spain (72.1), France (71.5), Greece (59.8), Italy (59.5), and Portugal (58.0) for an average of 81.7 for all 15-member EU. The United States is the most competitive nation in the world with an index of 119.9, while Japan has an index of 68.9, which is the lowest for the G-7 countries, with the exception of Italy. Column (3) shows the degree of inefficiency of each EU member relative to the EU average. That is, Column (3) gives the difference between the international competitiveness index of each EU country with respect to the EU average of 81.7 in 2001. These data provide, of course, the same information as Column (2), but present that information in a way that permits combining the competitiveness results shown in Column (3) with the effective corporate tax rate results presented in Column (4) (repeated from Table 2). Column (5) of Table 3 shows the sum of the inefficiency index with respect to Finland of each EU country in Column (3) and the effective corporate tax rate in Column (4), and provides a measure of the effect of the relative effective corporate tax pressure in each EU country on its level of international competitiveness. The data in Column (5) show that Ireland, with a small index of relative inefficiency (5.0) with respect to Finland and the lowest effective corporate tax rate (13.9), has the smallest index of competitive and tax disadvantage among EU countries (18.9). Finland comes second with an index of 29.8; Austria is third with an index of 30.8, all the way to Spain with an index of 52.0, France with 61.3 and Italy with 75.8, for an average of 45.2 for all 15 EU countries. Column (6) of Table 3 shows the overall index of the combined competitiveness and tax advantage (−) and disadvantage (+) of each EU member with respect
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to the EU average. Ireland comes out with the highest relative competitiveness and tax advantage with an index of −26.3. This means that taking into account the international competitiveness of Ireland, as modified by its relative effective corporate tax rate, investing in Ireland provides an overall competitive advantage of 26.3% with respect to the average EU country. Finland provides an average relative advantage of 15.4%, Austria 14.4%, the Netherlands and Sweden 11.1%, Luxembourg 10.4%, Belgium 3.3%, and Denmark 2.2%. All the other nations face an average overall competitiveness and effective corporate tax disadvantage. This is 4.6% for Greece, 6.2% for the United Kingdom, 6.8% for Spain, 7.2% for Germany, 14.0% for Portugal, 16.1% for France, and 30.6% for Italy. In conclusion, the data in the last column of Table 3 show that there are very powerful forces for EU and outside multinational corporations not to invest in Italy, France, and Portugal but to prefer Ireland, Finland, Austria, the Netherlands, Sweden, Luxembourg, Belgium, and Denmark, in that order, among EU countries. Competition among EU countries to attract inward investment is likely to intensify as a result of the creation of the euro at the beginning of January 1999 and its circulation at the start of 2002 since the single currency removes exchange rate risks and makes it more tempting for firms to shop around about where best to locate their businesses within the EU (see, OECD, 1998).
5. Tax harmonization in EU countries The data of Table 3 show that differences in effective corporate tax rates often reinforce rather than dampen differences in international competitiveness in EU countries, in encouraging or discouraging investing in the nation on the part of the nation’s and foreign multinationals. For example, Ireland does well both on competitiveness and on taxes, and it represents the best location for business to invest. Indeed, and as we have seen, the data in the last column of Table 3 show that Ireland provides an overall competitiveness and tax advantage on investing there in excess of 26% with respect to the EU average. On the other hand, Italy has both a competitive and a tax disadvantage of 22.5% with respect to the EU average. These results would seem to lead to the conclusion that tax harmonization in the EU countries is absolutely essential in order to establish a level-playing field for all types of investments (domestic, EU, and others). This, however, is not the case. The reason is that the tax pressure in a country only shows the costs of taxation without showing the benefits provided by tax money and both benefits and costs are necessary to properly evaluate the incentive or disincentive that the nation’s tax system provides in investing in the nation. A high-tax country may, nevertheless, be a good place in which to invest if the nation uses the tax money efficiently to provide infrastructures and other services that would be more expensive for the firm to provide for itself. A firm is willing to pay even a high tax for the privilege of doing business (i.e., producing and/or selling) in a rich market, in a market
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with good schools and a healthy environment in which the firm’s officers and employees would be willing to work and raise their families, and in a market with good infrastructures and a well-trained labor force and a well-functioning labor market. But it is impossible to determine the incentives or disincentives provided by the nation’s tax system without at the same time estimating the benefits that firms get from the tax money that they pay. For example, in the 1980s, both Switzerland and Germany imposed a tax on interest income generated in their country, but the Swiss tax was successful and it was retained because the Swiss banking system provided adequate benefits to investors (not least of which was bank secrecy), while the Germany tax was a failure and had to be removed because little or no direct benefit was received by investors from the tax paid, and if Germany had not removed the tax it would have lost this tax base in view of the high international mobility of capital that existed even then. Thus, looking only at the tax burden without at the same time also looking at the benefit from the tax tells us very little about the effect of the tax on the location decision of firms and individuals. Since the tax benefits that firms get from their tax money differ from firm to firm, however, tax harmonization may neither be feasible nor useful in the EU. This would be like wanting to charge the same price for products of different quality. What EU nations should strive is to provide services to businesses that justify the tax money that they pay (i.e., link benefits more closely to taxes) rather than try to harmonize taxes. A high-tax country would not be at a disadvantage in attracting and retaining firms, highly skilled workers, and entrepreneurs in relation to a low-tax country if the high-tax country provides services commensurate with the high taxes. In short, the countries with the highest-tax benefit/cost ratio will attract and retain firms and individuals, while the countries with a low ratio will lose them (see, Fratianni, Salvatore, & von Hagen, 1997). Thus, one way for a country to improve its position would be either to reduce taxes or increase the benefit that firms and individuals receive from the taxes they pay. Hence, the fear that tax competition will reduce taxes excessively in the EU countries is unfounded — unless firms and individuals were not to behave rationally or were unable to calculate correctly the benefits that they receive from their tax money. But as the results of the survey shown in Table 2 show, this does not seem to be the case. Tax competition among governments may be as beneficial as competition among firms — it should be encouraged, not discouraged. To be sure, statutory corporate tax rates have fallen by several percentage points in the EU during the past 3 years and more reductions are likely to follow in the near future particularly in those countries, such as Italy, which seem to have the lowest tax benefit/cost ratio. In any event, tax harmonization as called by the German and French governments is next to impossible because it requires unanimity in decision-making, and low-tax countries such as Ireland and the United Kingdom are strongly opposed to it. Most other countries are also opposed to tax harmonization because fiscal measures are some of the few remaining policy options left to them. Most firms and individuals in the EU are strongly opposed to
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tax harmonization because of their strong suspicion that taxes would be harmonized upward. Knowing the quarters from which the calls for tax harmonization in the EU come from (i.e., France, Italy, and Germany — some of the highest-tax countries) this suspicion cannot be said to be entirely misplaced. What tax competition is likely to do is to reduce the number and level of redistributive taxes in the EU since, by their very nature, they are non-benefit taxes. The EU finance ministers did agree in December 1997 on a voluntary code of conduct in business taxation so as to avoid or eliminate “harmful” tax competition, by which they meant special tax regimes considered to be discriminatory by business. EU officials are now investigating some 200 tax breaks thought to be harmful (tax dumping) and subject to being abolished by the year 2003 — but this is not tax harmonization. Of course, tax competition occurs not within the EU but also between the EU countries and other countries, particularly the United States, which does better than any EU country on international competitiveness and probably also on tax competition. Here, there is not even the talk of tax harmonization. But OECD (1999) is developing an international code against “harmful” tax competition. And with the world becoming more and more open to international trade and factor movements, it is crucial for EU member countries to link more closely their taxes to the benefits that they provide — lest they lose even more international competitiveness to the United States. In fact, most EU member countries have reduced or are moving toward reducing taxes.
References Buijink, W., Janssen, B., & Schols, Y. (2000, January 1). Evidence of the effect of domicile on corporate average effective tax rates in the European Union. MARC Working Paper 3/2/2000-11. Dunning, J. H. (1995). Think again professor Krugman: Competitiveness does matter. The International Executive, 37(4), 315–324. Fratianni, M., Salvatore, D., & von Hagen, J. (Eds.). (1997). Handbook of macroeconomic policies in open economies. Westport, CT: Greenwood Press. Institute for Management Development. (1998/2001). The world competitiveness yearbook. IMD: Lousanne. Krugman, P. (1994, March/April). Competitiveness: A dangerous obsession. Foreign Affairs, 28–44. OECD. (1998). Harmful tax competition: An emerging global issue. Paris: OECD. OECD. (1999). EMU: Facts, challenges and policies. Paris: OECD. Porter, M. (1990). The comparative advantage of nations. New York: Free Press. Salvatore, D. (Ed.). (1993). Protectionism and world welfare. New York: Cambridge University Press. Salvatore, D. (1998). Globalization and international competitiveness. In J. Dunning (Ed.), Globalization, trade and foreign direct investments (pp. 1–18). New York: Praeger. Salvatore, D. (2001). The economic performance of small versus large countries. In D. Salvatore & M. Svetlovic (Eds.), Small states: Challenges and opportunities (pp. 71–90). New York: Palgrave. World Economic Forum. (2000–2002). The global competitiveness report (2000–2002). Geneva: WEF.
Relative taxation and competitiveness in the European Union: what the European Union can learn from the United States Dominick Salvatore∗ 1 Red Oak Road, Bronxville, NY 10708, USA Received 5 January 2002; received in revised form 30 January 2002; accepted 1 March 2002
Abstract In recent years, there has been a great deal of discussion and controversy about the need to harmonize taxation in the European Union (EU). High-tax countries such as Germany, France and Italy are demanding the harmonization of taxes in order to establish a level-playing field and thus avoid the loss of foreign direct investments to countries such as Ireland and the United Kingdom, which have much lower corporate and personal income taxes. The paper presents reasons why tax harmonization in the EU countires may be neither feasible nor desirable and concludes that there is much that the EU can learn from the United States in the tax field. © 2002 Society for Policy Modeling. Published by Elsevier Science Inc. All rights reserved. Keywords: Effective tax rate; International competitiveness; Level-playing field; Relative taxation; Statutory tax rate; Tax harmonization
1. Introduction In recent years, there has been a great deal of discussion and controversy about the need to harmonize taxation in the European Union (EU). Even after the wave of recent tax reductions, some countries, such as Germany, France, and Italy, remain high-tax countries. These countries are demanding the harmonization of taxes in ∗
Tel.: +1-914-961-2917; fax: +1-914-771-7791. E-mail address: [email protected] (D. Salvatore).
0161-8938/02/$ – see front matter © 2002 Society for Policy Modeling. PII: S 0 1 6 1 - 8 9 3 8 ( 0 2 ) 0 0 1 1 9 - 9
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order to establish a level-playing field in the EU and, thus avoid the loss of foreign direct investments and, indeed, the migration of some of their firms, entrepreneurs and highly skilled people to countries such as Ireland and the United Kingdom, which have much lower corporate and personal income taxes. In this paper, I will conclude that, although differences in taxation affect international competitiveness, tax harmonization in the EU countries may be neither feasible nor desirable. Here, there is much that the EU can learn from the United States — a country with the most competitive economy in the world and with lower taxes than most EU members — and where there is not even a thought being given to harmonizing taxes among states. Indeed, in the United States, taxation is an important element of interstate competition in attracting investments from other states and from rest of the world. Trying to harmonize taxes across EU countries is neither feasible nor desirable.
2. Relative tax pressure in EU countries Taxation can influence the international competitiveness of a nation in a crucial way. Indeed, EU countries seem to increasingly compete with tax policies. Table 1 shows the relative tax pressure in the EU members in 2000. Column (2) of Table 1 shows that the corporate tax rate ranged from a low of 24% in Ireland to a high Table 1 Relative tax pressure in the EU, US, and Japan in 2000 Country
Corporate tax rate
Income tax rate for individuals
Government spending
Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg The Netherlands Portugal Spain Sweden United Kingdom
34.0 39.0 32.0 29.0 41.7 40.0 40.0 24.0 37.0 33.0 35.0 32.0 35.0 28.0 30.0
32.0 40.0 35.0 27.0 35.0 31.0 15.0 27.0 34.0 11.2 37.5 25.0 25.0 31.0 20.0
51.8 49.6 53.7 45.3 52.6 47.6 43.3 28.9 48.1 37.2 45.2 46.6 40.6 54.9 39.1
Average EU
34.0
28.4
45.6
United States Japan
35.0 30.0
15.0 10.0
28.9 39.3
Source: WEF, 2000–2002.
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of nearly 42% in France, with an average of 34% for the 15-member EU. The corporate tax rate is relatively low in Sweden (28%), Finland (29%), and the United Kingdom (30%) and relatively high in Italy (37%), Belgium (39%), and Germany (40%). These compare with a corporate tax rate of 35% in the United States and 30% in Japan. Thus, if a multinational corporation, European or otherwise, shops around (as it often does) for a lower corporate-tax-rate country in which to set up production and sales facilities, it surely has ample choice within the EU, and it is the loss of such investments that high-corporate-tax countries experience that leads them to demand tax harmonization. Column (3) of Table 1 shows that personal income tax rates also differ widely among EU countries. They were lowest in Luxembourg (11.2%), followed by Greece (with 15%), the United Kingdom (20%), Portugal and Spain (25%), Ireland (27%), Sweden and Germany (31%), Austria (32%), Italy (34%), France (35%), the Netherlands (37.5%), and Belgium (40%), with an average of 28.4% for the 15-member EU in 2000. These rates compare with the very low rate in the United States (15%) and Japan (10%). It is clearly advantageous for highly skilled individuals and entrepreneurs to work and start new economic activities in Luxembourg and the United Kingdom, within Europe, and especially in the United States, outside Europe. Although Japan has the lowest personal income tax rate, it imposes many restrictions on the migration of even highly skilled people and entrepreneurs and on the setting up of new firms as not to provide much attraction for individuals and entrepreneurs to relocate there. Finally, Column (4) of Table 1 shows the level of overall government expenditures as a percentage of GDP in the EU member countries, and in the United States and Japan in 2000. These figures can be used as a general index of total fiscal pressure in the various nations. The values range from a low of 28.9% for Ireland to a high of 54.9% for Sweden, with an average of 45.6% for EU in 2000. Germany has a rate of 43.3%, Italy 48.1%, and France 52.6%, as compared with 28.9% for the United States and 39.3% for Japan. Europe is simply a high-tax-pressure area in relation to the United States and Japan.
3. Statutory and effective corporate tax rates in EU countries The official or statutory tax rates given in Table 1 hide many exceptions, subsidies, and other tax benefits as to make official tax rates highly suspect as the true measure of fiscal pressure in a country. To overcome this problem, the Dutch Finance Ministry commissioned a study to calculate effective corporate tax rates in the various EU countries (Buijink, Janssen, & Schols, 2000). These are shown in Table 2. Column (2) of Table 2 shows the official or statutory average corporate tax rate from 1990 to 1996, and Column (3) shows the corresponding effective rate in the various EU countries (unfortunately, more recent data are not available or easily obtainable). From Columns (2) and (3) of the table we see that effective tax rates differ widely from the statutory rates. The difference is highest for Portugal
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Table 2 Effective tax pressure in the EU: 1990–1996 average Country
Statutory corporate tax rate (%)
Effective corporate tax rate (%)
Difference in effective rate in relation to average
Survey result on tax system in country (1999)a
Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg The Netherlands Portugal Spain Sweden United Kingdom
36.0 40.3 35.8 34.0 34.7 50.1 32.5 21.9 50.5 39.4 35.0 39.3 35.3 28.5 33.4
17.7 21.0 29.4 29.8 32.8 38.5 20.9 13.9 35.3 34.1 31.8 17.2 24.1 27.5 29.0
−9.2 −5.9 2.5 2.9 5.9 11.6 −6.0 −13.0 8.4 7.2 4.9 −9.7 −2.9 0.6 2.1
4.0 2.5 2.7 4.0 2.1 2.3 3.1 4.7 2.2 5.4 4.4 3.3 3.5 2.6 4.3
Average EU
36.5
26.9
–
–
Sources: for corporate tax rate, Buijink et al. (2000); for survey, WEF (2000). a Tax system in your country promotes bus. Competitiveness: 7, strongly agree; 1, strongly disagree.
(22.10), Belgium (19.29), and Austria (18.35) and smallest for Sweden (1.07), France (1.88), and the Netherlands (3.20), for an average difference of 9.59 for the 15-member EU countries. Thus, looking at the statutory rate gives a very distorted picture of relative corporate tax pressure in the various EU countries. Column (4) shows the difference in the effective corporate tax rate in each EU member with respect to the EU average and, thus provides a more appropriate measure of the relative corporate tax pressure in the various nations. The data in Column (4) show that Ireland has the lowest tax pressure with an effective corporate tax rate 13% below the EU average. It is followed by Portugal with an index of −9.7, Austria with −9.2, Greece with −6.0, Belgium with −5.9, and Spain −2.9. All other countries face an effective corporate tax pressure above the EU average, which is 0.6% above the EU average in Sweden, 2.1 in the United Kingdom, 2.5 in Denmark, 2.9 in Finland, 4.9 in the Netherlands, 5.9 in France, 7.2 in Luxembourg, 8.4 in Italy, and 11.6 in Germany. Thus, Germany, Italy, and France have the highest effective corporate tax pressure among EU countries and that explains why these nations are clamoring for tax harmonization. The last column of Table 2 shows the result of a survey conducted by the World Economic Forum (WEF) in 2000 in which a large sample of corporate CEOs in EU countries were asked to rank from 7 (the highest) to 1 (the lowest) the statement: “the tax system in your country promotes business competitiveness.” A survey is, of course, a very subjective measure, but it does indicate the perception of CEOs
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as to how they view the tax system in their country, and it is on these perceptions that they often base their investment decisions. For example, an Italian CEO will look to invest elsewhere (say in Ireland or England) if he or she believes that the tax system in other countries promotes business competitiveness much more than in Italy. The survey result show that the highest score (i.e., the nation where the tax system is perceived to be most supportive of business competitiveness) is Luxembourg with a score of 5.4. It is followed by Ireland (4.7), the Netherlands (4.4), the United Kingdom (4.3), Austria and Finland (4.0), Spain (3.5), Portugal (3.3), Greece (3.1), Denmark (2.7), Sweden (2.6), Belgium (2.5), Germany (2.3), Italy (2.2), and France (2.1), for an average of 3.4 for all EU members. Although the rank correlation between the effective tax rate and the survey results is not very high (32.5%), the survey results do show that German, Italian, and French CEOs perceive their countries to be high corporate-tax-pressure countries, as shown in Column (3) of the table.
4. Relative taxation and the international competitiveness of European Union countries Relative effective taxation affects the international competitiveness of nations. One measure of the overall international competitiveness of nations is calculated by the Institute for Management Development (IMD) in Lausanne, Switzerland. IMD defines international competitiveness as the ability of a country or company to generate more wealth for its people than its competitors in world markets. Four broad factors were used to measure the relative productivity of each nation. These are: (1) economic performance; (2) government efficiency; (3) business efficiency finance; and (4) infrastructure (the extent to which resources and systems are adequate to serve the basic needs of business). IMD used 286 criteria, grouped in the above four categories, to come up with an overall competitiveness of various nations. To be sure, measuring international competitiveness is an ambitious and difficult undertaking and, although useful, it faces a number of serious shortcomings. One is the grouping and measuring of international competitiveness of large and small countries together. It is well known, however, that large and small countries have very different industrial structures and face different competitiveness problems and so the results are difficult to interpret. Another serious shortcoming is that the correlation between the international competitiveness and the real per capita income of different nations does not seem to be very high. For example, the international competitiveness index is higher for Greece than for Italy even though the real per capita income is much higher in the latter than in the former. The question that naturally arises is: if Italy is less internationally competitive and productive than Greece, where is its much higher per capita income and standard of living coming from? In economics, we like to think that productivity determines per capita incomes and the standard of living, and so it is disconcerting to see such
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a blatant variance between expectations and reality. Despite these shortcomings, however, the international competitiveness results presented above do retain some validity because these are the general factors that investors examine in deciding where to invest. Krugman’s (1994) criticism that “international competitiveness is an irrelevant and dangerous concept because nations simply do not compete with each other the way corporations do, and that increases in productivity rather than international competitiveness are all that matter for increasing the standard of living of a nation” is not really valid. It is true that a country’s future prosperity depends on its growth in productivity, but this can certainly be influenced by government policies. Nations compete in the sense that they choose policies that promote productivity. As pointed out by Dunning (1995) and Porter (1990), and Salvatore (1993, 1998, 2001), international competitiveness does matter. Column (2) of Table 3 shows the international competitiveness index calculated by IMD (2001) for the 15 EU nations in 2001. As the most competitive among the 15-member EU nations, Finland is assigned an index of 100. Luxembourg is second with an index of 99.3. This means that, according to this index, Luxembourg is about 0.7% less internationally competitive than Finland. The Netherlands is third with an index of 97.7 and Ireland is fourth with an index of 95.0. They are followed by Sweden (93.4), Germany (88.7), Austria (86.9), Denmark (86.2), Belgium (79.1), the United Kingdom (77.6), Spain (72.1), France (71.5), Greece (59.8), Italy (59.5), and Portugal (58.0) for an average of 81.7 for all 15-member EU. The United States is the most competitive nation in the world with an index of 119.9, while Japan has an index of 68.9, which is the lowest for the G-7 countries, with the exception of Italy. Column (3) shows the degree of inefficiency of each EU member relative to the EU average. That is, Column (3) gives the difference between the international competitiveness index of each EU country with respect to the EU average of 81.7 in 2001. These data provide, of course, the same information as Column (2), but present that information in a way that permits combining the competitiveness results shown in Column (3) with the effective corporate tax rate results presented in Column (4) (repeated from Table 2). Column (5) of Table 3 shows the sum of the inefficiency index with respect to Finland of each EU country in Column (3) and the effective corporate tax rate in Column (4), and provides a measure of the effect of the relative effective corporate tax pressure in each EU country on its level of international competitiveness. The data in Column (5) show that Ireland, with a small index of relative inefficiency (5.0) with respect to Finland and the lowest effective corporate tax rate (13.9), has the smallest index of competitive and tax disadvantage among EU countries (18.9). Finland comes second with an index of 29.8; Austria is third with an index of 30.8, all the way to Spain with an index of 52.0, France with 61.3 and Italy with 75.8, for an average of 45.2 for all 15 EU countries. Column (6) of Table 3 shows the overall index of the combined competitiveness and tax advantage (−) and disadvantage (+) of each EU member with respect
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to the EU average. Ireland comes out with the highest relative competitiveness and tax advantage with an index of −26.3. This means that taking into account the international competitiveness of Ireland, as modified by its relative effective corporate tax rate, investing in Ireland provides an overall competitive advantage of 26.3% with respect to the average EU country. Finland provides an average relative advantage of 15.4%, Austria 14.4%, the Netherlands and Sweden 11.1%, Luxembourg 10.4%, Belgium 3.3%, and Denmark 2.2%. All the other nations face an average overall competitiveness and effective corporate tax disadvantage. This is 4.6% for Greece, 6.2% for the United Kingdom, 6.8% for Spain, 7.2% for Germany, 14.0% for Portugal, 16.1% for France, and 30.6% for Italy. In conclusion, the data in the last column of Table 3 show that there are very powerful forces for EU and outside multinational corporations not to invest in Italy, France, and Portugal but to prefer Ireland, Finland, Austria, the Netherlands, Sweden, Luxembourg, Belgium, and Denmark, in that order, among EU countries. Competition among EU countries to attract inward investment is likely to intensify as a result of the creation of the euro at the beginning of January 1999 and its circulation at the start of 2002 since the single currency removes exchange rate risks and makes it more tempting for firms to shop around about where best to locate their businesses within the EU (see, OECD, 1998).
5. Tax harmonization in EU countries The data of Table 3 show that differences in effective corporate tax rates often reinforce rather than dampen differences in international competitiveness in EU countries, in encouraging or discouraging investing in the nation on the part of the nation’s and foreign multinationals. For example, Ireland does well both on competitiveness and on taxes, and it represents the best location for business to invest. Indeed, and as we have seen, the data in the last column of Table 3 show that Ireland provides an overall competitiveness and tax advantage on investing there in excess of 26% with respect to the EU average. On the other hand, Italy has both a competitive and a tax disadvantage of 22.5% with respect to the EU average. These results would seem to lead to the conclusion that tax harmonization in the EU countries is absolutely essential in order to establish a level-playing field for all types of investments (domestic, EU, and others). This, however, is not the case. The reason is that the tax pressure in a country only shows the costs of taxation without showing the benefits provided by tax money and both benefits and costs are necessary to properly evaluate the incentive or disincentive that the nation’s tax system provides in investing in the nation. A high-tax country may, nevertheless, be a good place in which to invest if the nation uses the tax money efficiently to provide infrastructures and other services that would be more expensive for the firm to provide for itself. A firm is willing to pay even a high tax for the privilege of doing business (i.e., producing and/or selling) in a rich market, in a market
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with good schools and a healthy environment in which the firm’s officers and employees would be willing to work and raise their families, and in a market with good infrastructures and a well-trained labor force and a well-functioning labor market. But it is impossible to determine the incentives or disincentives provided by the nation’s tax system without at the same time estimating the benefits that firms get from the tax money that they pay. For example, in the 1980s, both Switzerland and Germany imposed a tax on interest income generated in their country, but the Swiss tax was successful and it was retained because the Swiss banking system provided adequate benefits to investors (not least of which was bank secrecy), while the Germany tax was a failure and had to be removed because little or no direct benefit was received by investors from the tax paid, and if Germany had not removed the tax it would have lost this tax base in view of the high international mobility of capital that existed even then. Thus, looking only at the tax burden without at the same time also looking at the benefit from the tax tells us very little about the effect of the tax on the location decision of firms and individuals. Since the tax benefits that firms get from their tax money differ from firm to firm, however, tax harmonization may neither be feasible nor useful in the EU. This would be like wanting to charge the same price for products of different quality. What EU nations should strive is to provide services to businesses that justify the tax money that they pay (i.e., link benefits more closely to taxes) rather than try to harmonize taxes. A high-tax country would not be at a disadvantage in attracting and retaining firms, highly skilled workers, and entrepreneurs in relation to a low-tax country if the high-tax country provides services commensurate with the high taxes. In short, the countries with the highest-tax benefit/cost ratio will attract and retain firms and individuals, while the countries with a low ratio will lose them (see, Fratianni, Salvatore, & von Hagen, 1997). Thus, one way for a country to improve its position would be either to reduce taxes or increase the benefit that firms and individuals receive from the taxes they pay. Hence, the fear that tax competition will reduce taxes excessively in the EU countries is unfounded — unless firms and individuals were not to behave rationally or were unable to calculate correctly the benefits that they receive from their tax money. But as the results of the survey shown in Table 2 show, this does not seem to be the case. Tax competition among governments may be as beneficial as competition among firms — it should be encouraged, not discouraged. To be sure, statutory corporate tax rates have fallen by several percentage points in the EU during the past 3 years and more reductions are likely to follow in the near future particularly in those countries, such as Italy, which seem to have the lowest tax benefit/cost ratio. In any event, tax harmonization as called by the German and French governments is next to impossible because it requires unanimity in decision-making, and low-tax countries such as Ireland and the United Kingdom are strongly opposed to it. Most other countries are also opposed to tax harmonization because fiscal measures are some of the few remaining policy options left to them. Most firms and individuals in the EU are strongly opposed to
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tax harmonization because of their strong suspicion that taxes would be harmonized upward. Knowing the quarters from which the calls for tax harmonization in the EU come from (i.e., France, Italy, and Germany — some of the highest-tax countries) this suspicion cannot be said to be entirely misplaced. What tax competition is likely to do is to reduce the number and level of redistributive taxes in the EU since, by their very nature, they are non-benefit taxes. The EU finance ministers did agree in December 1997 on a voluntary code of conduct in business taxation so as to avoid or eliminate “harmful” tax competition, by which they meant special tax regimes considered to be discriminatory by business. EU officials are now investigating some 200 tax breaks thought to be harmful (tax dumping) and subject to being abolished by the year 2003 — but this is not tax harmonization. Of course, tax competition occurs not within the EU but also between the EU countries and other countries, particularly the United States, which does better than any EU country on international competitiveness and probably also on tax competition. Here, there is not even the talk of tax harmonization. But OECD (1999) is developing an international code against “harmful” tax competition. And with the world becoming more and more open to international trade and factor movements, it is crucial for EU member countries to link more closely their taxes to the benefits that they provide — lest they lose even more international competitiveness to the United States. In fact, most EU member countries have reduced or are moving toward reducing taxes.
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