Free movement of capital, tax competition and the fiscal crisis of the welfare state

Details

Supervisors

Defraigne, Jean-Christophe

Faculty

Faculté des sciences économiques, sociales, politiques et de communication

Degree label

Master [120] en études européennes (UCLouvain / USL-B)

Abstract

ABSTRACT With increasing tax competition and free movement of capital, many believed the foundations of modern European welfare states and direct taxation of income were shackled. More than forty years have passed since the European Commission’s first failed proposal to stamp out harmful tax competition and harmonise direct taxation. However, most EU member states remain reluctant to depart from offering regulatory bargains to multinationals and the richest individuals. To this day, it is not clear why governments prefer the status quo in tax policy-making. The current ambiguity generates a substantial deadweight loss passed on to immobile workers, where fiscal policy is subject to majority voting. Given that median voters derive most of their income from labor, many analysts are puzzled that tax competition persists among European economies. This study determines the rationale behind states’ motivations to continue competing in fiscal policy, once the perspective of governments and interest group coalitions are taken into account. The research adopts an interdisciplinary approach, whereby elements such as history, international political economy and the economic, legal and functional nature of tax havens in tax competition are brought into scrutiny. The study is based on the European Union tax system and its member states, although, for certain issues, the US tax system is analysed. Part I examine what major statements from the economic and political science theoretical literature on tax competition restrict a more dynamic perspective on states’ behavior; and offers a stripped down review of the empirics on tax competition for corporate income. It is followed by an overview of the main components that characterise EU direct taxation on corporate income. Part II provides a political-economic history on the growth of tax competition and its relation to the welfare state, besides an investigation on the interest group coalitions in taxation in the European Union. Finally, Part III presents recent solutions suggested to the tax competition dilemma, going from EU initiative for the CCCTB to proposals for a return to the foundations of Bretton Woods. Following this policy-approach, the research concludes that member states’ behavior to engage in tax competition is led by: (1) the need to attract Foreign Direct Investment (FDI) to spur economic growth as a credible commitment to European economic integration; (2) interest group coalitions acting as political actors in the national and European sphere; (3) the rationale that no alternative is left to the present system of international taxation.