Politik und Gesellschaft Online
International Politics and Society 2/1999


Friedrich Heinemann:

Tax policy in the EU internal market: harmonisation or competition?

Vorläufige Fassung / Preliminary version

It is widely feared that the increasing ability of businesses to select the location with the lowest tax burden is gradually depriving states of the financial base for the provision of public goods - including services of the welfare state. This fear can be answered in the first instance by the argument that internationally mobile businesses also take account of the services provided by the state ("public goods") at these various locations for the benefit of their competitiveness. Investors are prepared to pay for these services, although no more than necessary. As far as taxes are concerned, they look for the location with the best price-services ratio and compare the various countries with this in mind. They thus put pressure on states to offer their services in the most efficient way and to omit expenditures which do not benefit location quality. The latter include, in particular, subsidies of individual economic groups. All of this benefits citizens as a whole. Of course tax competition improves the price-services ratio for public goods only if those who benefit from these goods also pay for them. This does not apply if companies transfer profits which they make from business activity in one country – which includes use of the state services provided by that country – to another country where taxes are lower. It also does not apply if foreign investors are offered such state services at a price below their costs by being granted tax breaks. States which do this are engaging in unfair competition to the same extent as states which do not collect tax at source on foreign capital investment. This is an area where reforms are clearly needed. The welfare state is not negatively affected by international tax competition to the extent that it also produces public goods (social peace) and that it functions in accordance with insurance logic (provision against risks and pension provision). There is, of course, pressure on the redistribution elements of the welfare state. Here it is necessary, on the one hand, to reduce redistribution to a level which is properly justified, while, on the other hand, maintaining the financial room for manoeuvre for justified and politically desired redistribution by means of efficiency in all state sectors. Empirically, little noticeable effect has been produced by international tax competition so far. But even if this were to grow stronger, tax competition should, on the whole, be welcomed due to the pressure for greater efficiency it produces. Furthermore, fiscal policy is one of the most important instruments in European monetary union which member states have retained to make adjustments in the light of specific national developments. Tax harmonisation would make it ineffective.

© Friedrich Ebert Stiftung | technical support | net edition juliag | April 1999