Although corporate tax rates in Europe, as elsewhere, have been trending downward during the last quarter century, the recent tax rivalry, sometimes referred to as a "race to the bottom," "tax dumping" or "predatory practices," was started by the smaller countries such as Ireland and Switzerland, and former Communist countries in Central and Eastern Europe, such as Hungary, Poland and Slovakia. The larger Western European countries have been forced to join the rivalry in order not to lose investments, especially from foreign multinationals. As a result of this rivalry the EU now has lower corporate tax rates than the North American and Asia-Pacific regions. In 1993 the EU had an average corporate tax rate of 38 percent. But in 2006 the EU average rate dropped to 25.8 percent, according to KPMG's Corporate Tax Rate Survey. The deepest cut was that of Ireland, whose tax rate dropped from 40 percent in 1993 to 12.5 percent in 2006. Since then Britain has reduced its rate from 30 percent to 28 percent. Germany is expected to reduce its rate from 39 percent to under 30 percent. If elected president, Nicolas Sarkozy will cut France's rate from 34 percent to 28 percent. Both the Organization for Economic Cooperation and Development (OECD) and the European Commission have been trying to stop the tax rivalry through "tax harmonization" schemes, but without much success. Europe's corporate tax rates might go even lower as the tax rivalry continues unabatedly despite the controversy surrounding it.
The controversy has to do with whether: 1 -- low corporate tax rates are by themselves effective in attracting and keeping investment; 2 -- governments are engaged in a zero-sum game where not much new investment is stimulated by low tax rates, and companies benefit at the expense of governments by shifting their investments to lower-tax countries; and 3 -- the loss of tax revenues by governments forces them to reduce expenditures on public goods and curtail essential social services. Academic research dealing with these issues has not yet arrived at a consensus. A country's other characteristics, such as its market size, rate of growth, the quality of its labor force and its infrastructure as well as its overall cost of doing business, might ultimately matter more in its attractiveness for both domestic and foreign companies. Besides, effective tax rates might differ significantly from statutory rates depending on various exemptions and deductions permitted by tax codes. In fact the decrease in corporate tax rates has often been accompanied by a reduction in exemptions and deductions as well as fewer loopholes, so that the positive effect on corporate net incomes and the negative effect on tax revenues have been somewhat mitigated. Furthermore the complexity of the tax codes as well as the tax rates themselves matter to companies, as they compare the tax regimes of different countries.
We have not recently witnessed an intense international tax rivalry outside Europe. For example, despite occasional editorials in The Wall Street Journal asking for the US to join in the global tax competition, under the present Democratic-controlled Congress there is almost no chance for a reduction in US corporate taxes in the near future. In the US during the presidency of Ronald Reagan the top corporate federal tax rate was reduced from 46 percent to 34 percent. With the federal and state corporate taxes combined, the US currently has a tax rate of 39 percent, which is the second highest after Japan among developed countries. Turkey, however, has already joined the tax rivalry in Europe. Based on the new Corporate Income Tax Law 5520, enacted last June, the Justice and Development Party (AK Party) government has cut the corporate income tax rate from 30 to 20 percent and simplified the tax system, as an indirect measure to attract foreign direct investment (FDI), reflecting its awareness of the intense international tax competition in its region. Bulgaria and Romania have corporate tax rates of 15 percent and 16 percent, respectively.
Will the tax rivalry in Europe end with the stabilization of corporate income tax rates at a certain level or will it end in the abolition of corporate income tax? There is the long-standing economic argument that people, especially as consumers and workers of corporations, not corporations themselves, ultimately pay the corporate tax, in terms of higher prices and lower wages, respectively. Therefore it is an additional burden, besides the personal income tax and other types of taxes, imposed on people, with corporations merely acting as tax collectors for the state. Whether Europe, pushed to the limit by the current tax rivalry, will pioneer the global abolition of the corporate income tax is an intriguing question. But for political reasons I do not see that happening. Most people as voters whom politicians usually follow in enacting legislation still believe that it is the "rich" corporations, and not they themselves, who ultimately pay the corporate tax.
