Fair tax competition vs. harmful tax competition

By Patricia Lampreave

One of the consequences of globalization is the increased openness of economies and the interdependence of States. We have to consider that each national tax system is now unavoidably conditioned by other tax sovereignties. In this context, tax competition between States is inevitable.

Tax competition has positive things: it restrains the appetite for higher taxes, prevents tax cartels, and promotes investment and economic growth. It spurs productivity and innovation. Tax competition puts pressure on States to become more efficient on how they raise and spend taxes.

At first sight, there is no particular reason for two countries to have the same levels of tax. Although differences in tax systems may have implications for other countries, these are essentially political decisions for national governments. Depending on the decisions taken, the levels of tax may be high or low relative to other countries and the composition of the tax burden may vary.

Consequently, whether or not a country modernizes its fiscal infrastructure (for example, by reducing rates or broadening the base to promote greater neutrality) is principally a matter for domestic policy and countries should be free to design their own tax systems as long as they abide by internationally accepted standards.

It is relevant to distinguish fair tax competition from harmful tax competition, since decades there is a global consensus that the second should be countered. Since the 90s the OECD and the EU have fixed several criteria to identify and neutralize harmful tax regimes/practices.

Harmful tax competition has been defined as a fiscal policy implemented by initiative of a country that offers a wide range of tax incentives and advantages to attract mobile factors (investment) to that country in the absence of transparency and the effective exchange of information with other countries. A clear manifestation of unfair competition is a “ring-fencing strategy”. Under such a strategy, the country with said regime would not be affected by the financial erosion of its own preferential tax base, as the regime would only have an adverse effect on foreign tax bases. Under certain preferential regimes, for instance, , a “substantial economic presence or a real economic activity” of the company may not be required, via a tax ruling granted by the State.

In contrast, fair tax competition can be defined as a decision made by a country to reduce the tax burden of its taxpayers, either by lowering statutory tax rates or by granting tax credits to both resident and non-resident entities. Exchange of information with other tax authorities and full transparency in respect of the tax system are also required.

The leading role of the OECD in eradicating harmful tax competition for decades cannot be denied ( you can visit the OECD website, action 5 of BEPS), but for decades the tax practice of certain states has contradicted the standard fixed by the OECD.

From the EU side, the EU’s Code of Conduct Group, continued, since the Primarolo Report (1999),  to rule the application of the stand-still (Member States should not introduce new harmful tax measures) and roll-back clauses (Member States should abolish existing harmful measures). The Group, not as transparent as the OCDE, is now paying particular attention to this point and making its work more easily available to the public, which is an excellent measure.

I believe that, in order to establish a global level playing field, to agreeing on a common corporate tax base or ensuring a minimum effective tax rate for all companies could be seen as something positive, even if this goes against the notion of fair tax competition between States. However, it cannot be ignored that the EU has tried to bring these proposals forward, but it has not been politically feasible, as Member States have rejected both. Perhaps, fixing a floor for statutory tax rate could be a good idea, but since countries with high statutory tax rate have allowed companies to pay a reduced effective tax rate, at first it may not be the most effective solution. Considering that many countries have already fixed a minimum effective tax rate for all companies operating in their territories, why not fix a minimum global effective corporate tax rate?; why not apply a minimum standard for fixing a common corporate taxable base for corporations despite their location? I am not referring to the current EU proposal of a CCTB, but to a global minimum standard for a CCTB applied to all companies, despite the size, legal form, or revenues.