Corporate Taxation
Capital mobility

The share of capital income taxes in GDP is 1.2% less on average in the European Community than in the United States, and EC governments are known to be no more lenient in taxing capital than that of the US. In Discussion Paper No. 416, Research Fellow Alberto Giovannini and James R Hines Jr draw two tentative conclusions: either effective tax rates are high but tax bases are low because of higher avoidance and evasion in Europe; or both effective rates and assessed bases are low because the high elasticities force governments to keep rates low.

Giovannini and Hines analyse the existing system of capital income taxation in Europe in order to highlight the most serious distortions. They find that countries rely on territorial taxation and withholding taxes in order to ensure revenue in the presence of high international capital mobility, and that continued European integration will increase the problems of administering such a system.

They propose a model of residence-based corporate taxation that preserves national tax sovereignties while minimizing the distortions arising from international capital mobility. Analysis of such models may help to clarify where technical and administrative issues end and political issues begin.

Giovannini and Hines propose first that corporations should be taxed throughout Europe at a uniform rate, higher than the country-specific corporate tax rates, which can differ. This uniform tax is due to the government of the country in which income is earned, and no distinctions are made between foreign subsidiaries and foreign branches. This uniform tax is accompanied by a system of country-specific rebates, which are not paid to the corporations, but rather to their owners.

They also propose that the definition of taxable income should be uniform, that foreign income within Europe should be exempt from taxation by the country of corporate residence, and foreign income outside Europe taxed at the common uniform rate. Corporate income should be attributed to shareholders without deferral, and individuals should receive rebates from their home governments equal to the difference between the taxes paid by the corporations they own and the individuals' national tax rates on corporate income. Also, withholding taxes should be eliminated and a clearing system established to reallocate corporate income taxes from source countries to the countries of shareholder residence.

They conclude with a discussion of the justifications for applying such a system of corporate taxation and of the likely effects of this reform on European countries' revenue from capital income taxes. While there would be some reallocation of revenue in line with the net-investor position of individual countries in the European Community, the effects of the reform on tax competition and on the elimination of tax loopholes that encourage evasion might be overwhelming.

Capital Flight and Tax Competition: Are There Viable Solutions to Both Problems?
Alberto Giovannini and James R Hines Jr

Discussion Paper No. 416, May 1990 (IM)