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Tax harmonisation in Europe: Moving forward

Tax harmonisation has been controversial since the establishment of the European Economic Community, and corporation tax proposals are currently on the table in the EU. Although tax competition can be beneficial, tax harmonisation could curb tax competition that leads to the under-provision of public goods or to burden-shifting from mobile to immobile tax bases. As yet, no agreement has been reached on any ambitious harmonisation plan for mobile tax bases. This column explores the possibility of implementing partial tax harmonisation for corporate taxation and the taxation of the banking sector.

The issue of tax harmonisation has been repeatedly debated in the EU since the European Economic Community was established. Substantial tax harmonisation exists in the area of indirect taxation, and proposals regarding corporations are on the table, such as the project of Common Consolidated Corporate Income Tax (CCCTB, see European Commission 2011a). According to widely accepted economic theory (Zodrow and Mieszkowski 1986), tax harmonisation is a way to curb tax competition that leads to either the under-provision of public goods or to burden-shifting from mobile to immobile tax bases. However it can also be argued that tax competition is beneficial as a way of taming the unchecked Leviathan – an ever-growing state. As yet, no agreement has been reached to implement any ambitious harmonisation plan on mobile tax bases. In Bénassy-Quéré et al. (2014), we explore the possibility of implementing partial tax harmonisation for corporate taxation and the taxation of the banking sector.

In the economic literature, coordination among a subset of players is not always beneficial. In the area of tax harmonisation, however, Konrad and Schjelderup (1999) demonstrate that, in the standard framework, tax harmonisation among a subset of countries is Pareto improving if tax rates are strategic complements, which is the case for corporate taxes (see below for empirical evidence). Furthermore, Conconi et al. (2008) show that those countries outside the coordination will impose a discipline on the coordinated ones, hence partial harmonisation benefits all countries relative to both global harmonisation and no harmonisation at all. A perhaps even more important argument for proceeding to harmonisation within a subset of countries comes from the substantial administrative costs for businesses arising from the large differences in the definition of tax bases across EU Member states, some of which are saved even with partial harmonisation. Indeed, our first proposal regarding corporate tax is more modest than harmonising tax rates, and the case for enhancing efficiency is even higher when one simply wants to harmonise tax bases on the basis on mutual agreement among a group of countries.

Reviving the CCCTB project through an ‘enhanced cooperation’ agreement

Over the last 20 years, corporate income tax (CIT) rates have experienced a steady decline in the EU. Although the fall of statutory rates has been accompanied by base broadening, effective rates have been declining too (Figure 1).1

Figure 1. Corporate income and value-added tax rates in the EU, 1995–2014 (unweighted averages in %)

Source: European Commission.

Such a decline may have resulted from a deliberate strategy to shift taxation from direct to indirect taxes, and from high- to low-elasticity tax bases, in an attempt to reduce the deadweight loss of taxation. Indeed, the value-added tax has increased on average over the period. Still, the empirical literature on the CIT tends to validate the ‘race-to-the-bottom’ interpretation of Figure 1. For instance, Devereux et al. (2008) find that a one percentage-point fall in the average foreign statutory CIT rate reduces the home rate by 0.67 percentage points.

It is difficult to assess the welfare losses related to the ‘race-to-the-bottom’ illustrated in Figure 1, not least because there is no proof that the CIT rates that prevailed in the mid-1990s were ‘optimal’. In contrast, tax competition may be viewed as a way make governments more efficient, in line with Tiebout’s (1956) argument that taxpayers ‘vote with their feet’.

However, European governments do not only compete on tax rates; they also compete on tax bases. For instance, they offer favourable amortisation for some specific investments, deductions for interest payments, or special treatment on patent royalties. In this context, it is unlikely that tax competition will promote efficiency. On the contrary, multinational companies may take advantage of differences in tax codes (through transfer pricing or intra-group lending) to escape taxation, or to pay taxes in a different jurisdiction from the one where they enjoy public inputs. Additionally, interest deductions introduce a bias in funding choices, as the taxation of the same capital return is different depending on whether the investment is financed through equity, retained earnings, or debt (Figure 2).

Figure 2. Effective average tax rate on corporations depending on the source of finance, 2012 (in %)


Source: ZEW (2012).

Hence, the primary objective of tax harmonisation in the EU should be to eliminate tax distortions rather than a mere harmonisation of tax rates. The CCCTB project is consistent with such an approach. Base harmonisation would make tax competition more transparent in that only tax rates would matter. In turn, base consolidation would eliminate intra-EU profit-shifting – corporate profit would be consolidated at the EU level and apportioned to the different governments according to a single apportionment formula that would depend on a combination of turnover, wage bill, number of employees, and physical capital. Each member country would then have the ability to tax its apportioned share at its own CIT rate. Tax rate competition would continue, but with due account of public input provision in each member state.

In Bénassy-Quéré et al. (2014), we argue that the CCCTB project, which was rejected by the Council in 2011, should be revived in the framework of ‘enhanced cooperation’ (at least nine member states), or even as an ad hoc initiative like the one that kicked off the Schengen process in the 1980s. There are three reasons for this.

  • First, participating countries would reap immediate gains in terms of reduced compliance costs and extended ability to carry losses for firms, and reduced cases of ‘double non-taxation’ for governments.
  • Second, a group of possibly large countries speaking with one voice would have more weight to convince third countries (either EU members or not) to cooperate (see what the US has obtained from non-cooperative countries in recent months).
  • Third, in the event of the creation of a ‘fiscal capacity’ at the level of the Eurozone (see Van Rompuy 2012), a harmonised CIT could be a good candidate to fund such capacity. Another ‘natural’ candidate for this would be to fully harmonise the taxation of the banking sector.
Implementing a financial activity tax (FAT) to complement the banking union

Tax distortions are even more detrimental in the banking sector, where the banking union initiative intends to introduce a level playing field and to cut the feedback loop between banks and national governments. In fact, banks across the banking union will continue to be subject to heterogenous taxation. Not only the CIT differs across the Union, but banks are also subject to specific taxes (wage taxes, stamp duties, liability taxes, and bonus taxes – as well as the new fees to fund the Single Resolution Fund) that are mostly heterogenous. On top of that, there are two distortions between banks and non-banks:

  • First, banks are not subject to VAT;
  • Second, some of them receive an implicit subsidy related to their status of ‘too big to fail’.

According to the International Monetary Fund (2014), the implicit subsidy could be sizeable.

Therefore, we suggest that all specific taxes – as well as fees on the banks covered by the Single Supervisory Mechanism – should be transferred at the banking union level and merged into a single Financial Activity Tax (FAT), which would make taxation easier and would not necessarily increase the tax burden. Initially suggested by the IMF (2010), the FAT is a levy on the sum of remunerations and profit – a proxy for banks’ value-added. Several versions of the FAT can be designed. Based on the calculations provided by the European Commission (2011b), a 5% FAT applied to the banking union could raise €10.6 billion to €23.4 billion annually, depending on the scheme adopted.

The FAT could allow the Single Resolution Fund to receive a yearly budget that would accumulate until a specific size is reached. After the fund has been filled, it could constitute the first building block of a Eurozone budget, while countries covered by the banking union but not in the Eurozone would see their contributions returned to their national budgets. Excluding non-euro countries, a 5% FAT could contribute €10.3 billion to €20.9 billion per year.

Transferring FAT receipts to the Single Resolution Fund would accelerate the building-up of a credible fiscal backstop to the banking union. The next step would be to raise the CIT of the banks at the level of the Eurozone (at a single, low rate), with national governments still applying surcharges to meet their national CIT rates (hence avoiding a discrimination between banks and non-banks). A rough calculation suggests annual receipts on the order of €20 billion. This amount could fund Eurozone-wide investments in physical or human capital, national expenditures being reduced accordingly.

We believe that the discussions on fiscal union as a complement to the European Monetary Union should come along with deep reflections on the need to identify appropriate ‘own resources’ for a Eurozone budget. The banking union here offers a natural step in this direction – any attempt to create a budget at the level of the Eurozone should be considered an occasion to erase the existing tax distortions that still impede a smooth functioning of the single market.


1. The fact that corporate tax receipts have remained broadly stable as a percentage of GDP can be related to increased profitability and incorporation over the period.


Bénassy-Quéré, A, N Gobalraja, and A Trannoy (2007), “Tax and public input competition”, Economic Policy, 22(50): 385–430.

Conconi, P, C Perroni, and R Riezman (2008), “Is partial tax harmonization desirable?”, Journal of Public Economics, 92: 254–267.

Devereux, M P, B Lockwood, and M Redoano (2008), “Do countries compete over corporate tax rates?”, Journal of Public Economics, 92: 1210–1235.

European Commission (2011a), Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), COM(2011) 121/4.

European Commission (2011b), Impact Assessment Accompanying the Document Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC, Volume 12, Annex 11.

IMF (2010), Financial Sector Taxation: The IMF’s Report to the G20 and Background Material, Washington DC.

IMF (2014), Financial Stability Report, Chapter 4.

Konrad K A and G Schjelderup (1999), “Fortress Building in Global Tax Competition”, Journal of Urban Economics, 46(1): 156–167.

Tiebout, C M (1956), “A Pure Theory of Local Expenditures”, Journal of Political Economy, 64(5): 416–424.

Van Rompuy, H (2012), “Towards a genuine economic and monetary union”, Report of the Presidents, 5 December.

ZEW (2012), “Effective tax levels using the Devereux/Griffith methodology”, Project for the EU Commission, TAXUD/2008/CC/099, Final Report.

Zodrow, G and P Mieszkowski (1986), “Pigou, Tiebout, property taxation, and the under-provision of local public goods”, Journal of Urban Economics, 19(3): 356–370.

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