Tax Competition and Harmonization in Federal Economies
The objective of the paper is an elaboration of the central economic problem of rational decentralized tax policy in an open economy setting. The paper shows that theoretical models which predict a tax rate reduction run in an environment of unrestricted
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Abstract The objective of the paper is an elaboration of the central economic problem of rational decentralized tax policy in an open economy setting. The paper shows that theoretical models which predict a tax rate reduction run in an environment of unrestricted interjurisdictional competition contrast to empirical evidence of considerable state and local tax rate differentials in countries with traditional subfederal tax autonomy. These findings seem to be due to coordination arrangements, which do not constrain tax rate autonomy. The major lesson for supranational EC tax policy targets is to enforce international tax base transparency and to concentrate on tax base coordination, since tax base erosions induced by the existence of tax havens are recognized as one decisive factor that constrains jurisdictional tax autonomy. Furthermore, tax rate harmonization by binding rate bands may even lead to undesirable third-best policies that create additional welfare losses in comparison to autonomous tax reforms which restructure national tax bases. •1 owe thanks to Andreas Haufl.er (Univ. of Konstanz) and to Peter Birch S¢rensen (Univ. of Copenhagen) for helpful comments and critical remarks on a first draft of the paper.
H.-J. Vosgerau (ed.), European Integration in the World Economy © Springer-Verlag Berlin Heidelberg 1992
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Introduction
The Single European Act, signed in February 1986, stipulates that the 12 member countries adopt measures to establish an internal market without internal frontiers for the movement of goods, services, persons, and capital by the end of 1992. The Treaty of Rome already recognized national fiscal instruments as distortionary in the Common Market and constituted cooperative measures with respect to trade: internal customs duties were abolished (Art. 3, 12-17), a common external tariff for all member countries was introduced for trade with noncommunity countries (Art. 3, 18-29), subsidies and excises were reorganized to prevent distortion of intracommunity trade (Art. 95-98), and a harmonized system of indirect taxes was required (Art. 99). A series of VAT directives led to the implementation of the invoice-type, multi-stage value-added tax system with widely harmonized tax bases in all member countries. In spite of these harmonization measures, the institution of border tax adjustments enabled the community members to choose the national VAT rates as well as excise tax rates independently without distorting transnational competition. Minor competitive distortions arising from cross border shopping have been tolerated by the national tax administrations. Despite growing shopping tourism 1 random border controls concentrated on large-scale smuggling and the import of illegal drugs. Direct taxes are not explicitly addressed in the EEC-Treaty. Art. 100 contains a general provision concerning the harmonization of those statutory regulations in member states which counteract the establishment and functioning of the Common Market. Nevertheless the Commission paid attention to the dire
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