Part 1 - AL-Tax

Chapter 8States and so have tax rates on interest income and financial wealth (Schjelderup,2002; Huizinga and Nicodème, 2004). The issue of a ‘race to the bottom’, puttingpressure on the financing of the welfare state and leading to a shift of the tax burdenfrom capital to labor, has been taken very seriously at both the EU and the OECDlevels. In the European Union, the issue was discussed at the informal ECOFINCouncil in Verona in April 1996 and led to the publication in 1999 of a code ofconduct for business taxation based on the work of a group of national experts ledby Dawn Primarolo of the UK Treasury. The report (Primarolo, 1999) – based on anonbinding peer-review exercise – identified 66 tax measures with harmful featureswhich Member States agreed to revise or replace. However, while specific regimeswere targeted, the report did not consider low statutory rates ‘harmful’. 7One important question is of course whether the decline in corporate tax ratesis the result of tax competition and whether there is a ‘race to the bottom’ underway. Since the seminal work of Case et al. (1993) and in the context of evolvingestimating and modeling techniques (Brueckner, 2003), several authors have triedto estimate whether jurisdictions of various natures were setting taxes in an interdependentfashion. In particular, Devereux et al. (2003) and Redoano (2004) foundsome evidence of strategic interaction in corporate tax setting for the OECDbetween 1992 and 2002 and for the EU-25 from 1980 to 1995. Looking at the issueof capital mobility, Krogstrup (2003) found a positive relationship between an indexof capital mobility and the tax burden in 13 European countries. The effect ofcapital mobility seems to be confirmed by Besley et al. (2001), who used tax reactionfunctions for five different taxes in the OECD between 1965 and 1997, finding thattax setting was generally interdependent and became more so with a more mobiletax base. In particular, they found more interdependence amongst EU countriesthan between EU and non-EU countries.There is, however, no strong evidence in the literature of the reason for thisinteraction – that is, whether it is the result of tax competition to attract mobiletax bases, yardstick tax competition in which countries try to mimic each other’stax policy to seek the votes of informed voters (Besley and Case, 1995), or simplyconvergence across countries in economic structures and/or dominant economicthinking (Slemrod, 2004). In addition, with the exception of Besley et al. (2001),all studies used statutory or forward-looking effective tax rates 8 (themselves verydependent on statutory rates). These results were recently challenged by Stewartand Webb (2006), who looked at the evolution of corporate tax burdens – measuredas corporate tax collected on GDP and on total taxes – in the OECD countriesbetween 1950 and 1999. Based on both a descriptive and a cointegration analysis,the authors found no evidence of a race to the bottom and little evidence of a185