Part 1 - AL-Tax

International Taxation Handbookexemption of capital income is an improbable event, since there are four mainfactors that could stop such a race to the bottom. 3 The first factor is capital mobility:In a subsequent article, Gordon (2000) added that capital is not perfectlymobile and therefore its ‘flight’ from taxation is costly. The second factor is therelationship between corporate taxation and personal taxation. As pointed out byGordon and MacKie-Mason (1995), corporate taxation serves as a backstop tolabor taxes to discourage individuals from converting their labor income into(otherwise untaxed) corporate income: Therefore, the tax rate differential cannotbe too big. The evidence supports the ‘backstop hypothesis’: As shown bySlemrod (2004), there is a strongly positive correlation between the top personalrate (levied on labor) and the top statutory corporate tax rate (levied on capital).This means that corporate taxes reduce benefits arising from the reclassificationof labor into corporate income, and thus offset tax avoiding practices.The third factor is related to the package of Maastricht rules. Further tax ratedecreases are harder given the EMU members’ urge of keeping public budgets inline with the Stability and Growth Pact. Although interpretation of the Maastrichtrules is now much less strict than at first, such constraints are generally bindingand may prevent countries from further tax cuts. A good example is provided byGermany. Before the political elections in 2005, both competing coalitions claimedthe need for lower corporate tax rates. However, the plan to cut tax rates failed asthe ruling coalition and the opposition did not agree on how to finance suchreform. 4The Stability and Growth Pact also affects the fiscal policies of non-EMUcountries, as long as they aim to enter the Monetary Union in the near future.These countries are indeed trying to keep public budgets under control even withincreasing difficulties and in some cases pre-commit themselves. An interestingexample of pre-commitment to enter the EMU is article 216 of the PolishConstitution, which states that, in line with Maastricht rules, it is ‘neither permissibleto contract loans nor provide guarantees and financial sureties thatwould engender a national public debt exceeding three-fifths of the value of theannual Gross Domestic Product’.The fourth, and to some extent decisive, factor is the role played by the EuropeanCommission. Article 2 of the EU Institutional Treaty outlines that communityobjectives (such as economic development, environmental care, improvement ofliving standards, economic and social solidarity) should come about ‘by the establishmentof a common market and economic and monetary union’. However, thisTreaty does not assign any general competence for tax matters to the EU. Thismeans that, at present, a federal tax system cannot be implemented and that the216