Part 1 - AL-Tax

International Taxation HandbookWildasin, 2003) are further features that will determine the equilibrium effect oftax competition.Finally, there is an unresolved debate in the economic literature about the meritsand demerits of tax competition, with the so-called Leviathan models finding a usefulrole for tax competition in curbing the tendency of governments to overextend thesize of the public sector (Brennan and Buchanan, 1980; Edwards and Keen, 1996).8.5.3 How well does the European Union fit the theory?Very few papers have sought to assess which of the features of tax competition modelsdescribed above best fit the European Union. Zodrow (2003, p. 660) underlinedthe basic difficulty of assessing the combined effect of some of these features sincethe economic literature ‘typically focus[es] on only one or two of the economiceffects of tax competition’. Such an assessment is therefore highly speculative at thisstage and more research on this issue is badly needed. 4 Assuming that MemberStates do in fact compete over corporate taxes, some broad predictions can be made.On the one hand, some features of the EU may theoretically mitigate the adverseeffects of corporate tax competition on the provision of public goods and the raceto the bottom predicted by the basic models, thus decreasing the need for policycoordination. The existence of a core-periphery model with some agglomerationforces, for example, is one element that may explain why large core countries maysustain a higher tax rate than small countries at the periphery. One can also assumethat there are economies of scale in the provision of public goods and that hence theproblems of underprovision decrease with the size of the population. The largedifferences in preferences across Europe coupled with a relative home bias ininvestment and an increasing (albeit still small) mobility of labor are other Europeancharacteristics that may also play a role.On the other hand, the absence of large-scale redistribution policies at the EUlevel, 5 and hence of corrective subsidies, a relatively widespread European taste forsocial protection, the general absence of a consolidated tax base for pan-Europeancompanies, and the increased mobility of capital are possible reasons why taxcoordination would be desirable. The existence of trade has ambiguous effects.On the one hand, trade between Member States may lead to specialization patternsand reinforce the inefficiency costs of tax competition but, on the other, the existenceof trade with the rest of the world allows for an elastic supply of capital andmitigates these costs.Two other features of the European Union are also interesting in this debate.First, it has a mix of large and small Member States. Theory predicts that, in182