Part 1 - AL-Tax

Chapter 8Parry (2003) used a model to assess the welfare losses of tax competition andintroduced, as additional scenarios, possibilities of capital flight from the EU, aLeviathan behavior with large states capable of influencing the after-tax rate ofreturn on capital, and noncompetitive governments (i.e. governments that are lesslikely to cut taxes, knowing that others may imitate them). He set the value of welfarecosts of tax competition that he considered ‘significant’ at 5% of capital tax revenues(corresponding to about 0.25–0.75% of GDP). His benchmark result showed that thisvalue is reached for a tax elasticity of capital between 0.3 and 0.9. He then unlockedthe capital supply elasticity at the EU level and allowed it to increase to 0.5 and 1(i.e. capital can progressively flee the EU). These scenarios respectively reduce thewelfare gains of coordination by about 25% and 50%. The ‘Leviathan’ scenariounsurprisingly reduced the welfare gains (although capital taxation may be too lowor too high depending on the parameters of the model). The same applied for thescenario of noncompetitive governments. The magnitude of these results wasbroadly confirmed by a study commissioned by the European Commission fromCopenhagen Economics (2004), in which the various scenarios of full harmonization,and harmonization of the bases with or without a minimum rate and/or equalyieldconstraints delivered welfare gains between 0.02% and 0.21% of GDP.Potential positive gains were also found by Beltendorf et al. (2006) and van der Horstet al. (2006) in two joint studies looking respectively at tax rates harmonization andconsolidation and formula apportionment.The gains may appear relatively small at first sight – and have been depicted assuch by several authors – but they are actually positive (meaning that there arepotential welfare gains in coordinating corporate taxes) and are as large as thoseexpected from some other important EU policies. A 0.5% welfare gain as a meanvalue from Sørensen (2001) compares well with the 0.6–0.7% gain expected from theremoval of all obstacles to the free movements of services stemming from the fullimplementation of the services directive (Copenhagen Economics, 2005a) and withthe 0.5% GDP increase 19 expected from EU enlargement (European commission,2001b). It also corresponds to more than one-fourth of the GDP increase (1.8%) attributableto 10 years of the implementation of the Single Market Programme as estimatedby the European Commission (2003b) (in line with the 1.1–1.5% GDP increaseestimated for the effect of the SMP until 1994 (European Commission, 1996)). 20 Thisresult includes the liberalization of network industries whose own effect is estimatedat about 0.6% of GDP (although Copenhagen Economics (2005b) estimates the totalEU welfare gain of liberalization of network industries at 1.9% of GDP).Finally, it should be noted that these models are by definition a simplificationof reality and do not capture a number of complicating factors (see Parry (2003)197