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Part 1 - AL-Tax

Part 1 - AL-Tax

Part 1 - AL-Tax

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Chapter 9the UE-15 countries average effective rates oscillate between 14.7% (Ireland), 36%(Germany), and 36.1% (Spain). The EU-10 countries’ effective tax rates range from9.7% (Cyprus) to 32.8% (Malta). Such heterogeneity confirms the fact that there isroom for further changes, especially in high-tax countries.Although there are some possible country-specific determinants of tax ratedecreases, the most convincing reason for such a generalized ‘race to the bottom’is tax competition. This phenomenon is becoming ever more important as theworld is integrating and production factors (in particular capital) are becomingincreasingly mobile. The argument for capital mobility was clearly shown byGordon (1986). In his model, he assumed the existence of both mobile (e.g. capital)and immobile factors (such as labor). Moreover, he observed that, in the absenceof market imperfections, capital flow would be such as to level returns throughoutthe world. Therefore, if a country introduced source-based capital taxation, itwould experience a flight of capital and would face a welfare loss. Other competingcountries would have no interest in taxing their capital. Indeed, if theyexempted capital income, they would import the capital in flight from the countrythat had introduced capital income tax, thereby enjoying a welfare improvement.The policy implication of Gordon’s model is that each country, interestedin attracting capital income and at the same time aiming to raise tax revenues,should tax immobile labor and ensure full exemption to capital.Evidence has supported Gordon’s forecast of a significant reduction in capitalincome taxation. For instance, Lee and Gordon (2005) found that in 1980–1989,the average top corporate tax rate was 41.3% (with standard deviation of 8.2%).In the period 1990–1997, it decreased to 34.8% (with a standard deviation of 6.5%).Moreover, Devereux et al. (2004) showed that countries compete both over thestatutory tax rate and the tax base, and that tax competition is positively relatedto the openness of countries. In line with Rodrik (1997), moreover, they showedthat the relaxation of capital controls stimulates tax competition and thusreduces both statutory and effective tax rates.9.3 <strong>Tax</strong> coordination ‘from the top’ in the EUAre big tax cuts likely to occur in the future? As we have seen, many countrieshave dramatically cut tax rates. Moreover, high tax rate heterogeneity supportsthe forecast that further tax cuts are not unlikely: In particular, it is not impossiblethat those members that did not initially implement significant tax cuts couldbe stimulated to follow the first movers. Despite this downward trend, full215

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