1. Research Essay
Considering the diversity of European tax policies and
the risk of tax competition between them, what are the
consequences on foreign investment and public
services?
Ixchel Falaize
Bachelor of Business Administration
IT Sligo, Ireland
Research tutor: Nicolas Barbaroux
Methodology tutors: Evelyne Downs & Sandrine Le Pontois

2. THANKS
I would like to express my gratitude to Mr. Nicolas Barbaroux, Associate
Professor in Economics at the University of Saint-Étienne, and my teacher tutor for
my research paper.
Both present and available, he guided me in my work, helped me to find ways
to move forward, provided tools and its intellectual and moral support throughout
my research and work. I thank him for coaching me and giving me advice.

3. TABLE OF CONTENTS
Introduction p. 1
I/ The issues of tax competition within the European Union p. 5
 A/ Divergent national taxation systems within the European
Union
p. 5
 B/ what is tax competition and what are its foundations? p. 10
 C/ Tax harmonization versus tax competition: the issue of the
European federalism
p. 14
II/ the consequences of a “fiscal war” on foreign investments
and public services within the European Union
p. 17
 A/ what happens when European countries compete on
taxation between themselves?
p. 17
 B/What are the differences between France and Ireland from
their respective tax systems? Should the European Union
converge to a tax harmonization?
p. 20
III/ The fiscal policy dilemma: tax heaven or the domestic
economy.
p. 21
Conclusion p. 23
Annexes p. 25
Bibliography and sources p. 30

4. 1
INTRODUCTION
Following the Great Financial Crisis (GFC), the increasing necessity to find an
economic recovery pre-empted the macro agenda of the European Union economy.
In this search of growth, the burning topic of taxation became a leading subject in a
context in which the EU rules (notably the ones on budgetary deficit) prevent the
States to be free to choose the appropriate instrument.
The convergence of taxation systems in Europe is a problematic which arises from the
birth of the European Community in 1957. Since 1960 a specific Commission was
established at the initiative of the European Commission to consider the advisability
of bringing closer the different taxation systems and to make them converge.
This problem is still not solved nowadays, because in Europe we observe
completely contradictory evolutions: on one side there is a strong opposition to the
convergence of systems, especially as taxation remains governed by the unanimity
system, that is to say, by the principle of respect for national sovereignty. On the
other side, we can see the opposite trend emerge to support convergence; for
instance, the initiative that comes from the European Commission to establish a
common consolidated tax base with regard to corporate taxes: These are initiatives
that demonstrate a political will to bring the tax systems closer by harmonizing the
corporate tax base .
Thus, taxation is a structural problem meaning that it necessitates a thorough
changing of economic reasoning while the States are in context in which economic
selfishness seems to prevail (for growth purposes).
Given the changes that seem to be contradictory and complex how to find
one’s way? To answer this question one must kept in mind some simple ideas.
Different voices emerge in Europe when the convergence of taxation arises.
The first idea is that Europe is a space where different cultures coexist and it’s right
that it should remain that way. There is in Europe different tax cultures, as much as,
its global cultural diversity. And if a reconciliation of these tax systems doesn’t appear
to be necessary for the European members, then it is not easy to make it happen.
The second idea is that Europe is a free market, i.e. it is a market which works
to facilitate the fluidity and flexibility of the economic relations between companies
at an European level, thus, we must eliminate taxes that represent barriers to this
market’s achievement: That is why VAT has been harmonized, that’s why there is no
customs duties within the European Union, that’s why there are directives that
eliminate some tax frictions about cross-border flows, dividends distribution matters,
among others.

5. 2
The third idea is that we must kept in mind that the European Union is a
mutual-help area based on common values , which means that all the Members
States must work together to discuss and to fight against fraud and tax evasion. This
also means that the tax legislation across the European Union must respect certain
fundamental values such as human rights, and by extension, therefore, the taxpayer’s
rights. The last idea that is, without doubt, the opposite of the three first points, is
that the European Union is a competition and competitiveness area. Tax competition
still exists in Europe; the European countries’ interests are clearly in conflict: large
states don’t have the same interests with regard to tax policies than the smaller
states. The small states tend to compete more or less fairly with large states to
attract foreign investment in their territories. This competition area is probably the
most ambiguous and problematic issue that affects the progress of a European
harmonization.
The discussion on tax competition can be illustrated by a duel between the
advocates of harmonization who fear the “race to the bottom”, and thus the gradual
disappearance of the taxation of the most mobile tax bases; and the advocates of tax
competition, for whom harmonization is a conspiracy of high-tax countries to force
their European partners to align with this model.
This led to a downward convergence of corporate tax rates in Europe. (See annex 1: Top
corporate income tax rates 1995-2009)
This convergence can be problematic since it brings about other issues to
consider such as the financing of public services which comes from taxes revenue
(corporate taxes, but also income and savings that are less mobile).
Infrastructure spending, workforce training, and the justice administration contribute
to the efficient functioning of businesses. Some of them also benefit from the direct
or indirect impact of public research efforts.
While tax competition exerted on the overall tax burden is considered as fair,
the European Union has been very clear that when tax competition is characterized
by the desire to attract foreign tax bases (thanks to different tax measures for foreign
investment), this form of competition is harmful. Therefore, this form of competition
cannot be accepted because the advantages for a handful of smaller geographic
areas, especially small states as previously mentioned, is significantly lower than the
loss recorded by the majority of countries that it may affect . Furthermore this type
of tax competition may also lead to higher taxes on relatively immobile bases (savings
or income) instead off the more mobile bases (capital).
In the current institutional and legal context of the European Union, the
Member States have the choice to offer to their domestic and foreign investors the
best opportunities according to the level of their taxes, and to set the tax systems
that they prefer. This way, they can choose to offer a wide range of public goods and
services or leave more room for the private sector.

6. 3
The problem is more complex if we keep in mind that a higher overall tax
burden does not necessarily discourage investment. For example, if a country has
developed in return an excellent educational system and provides high quality
infrastructure and public services. Similarly, a low overall tax burden does not
necessarily attract investment if education, infrastructure and public services are
poorly developed.
Thus, states face a fiscal policy dilemma: to reduce corporate tax burden so as
to improve their price competitiveness or encourage capital inflows; or to maintain a
high level of public expenses (particularly social insurances and pensions systems)
which implied to maintain or increase the level of taxes so as to finance them (in a
context of public debt burden). In addition, each country must also deal with national
and European requirements in terms of public expenditure commitments because of
the post-crisis austerity measures focused more on cutting public spending rather
than on higher tax levies.
Indeed, the corporate income tax rate has decrease between 1986 and 2009
about 36 points in Ireland ( from 48% to 12%) and about 3 points in France (from 36%
to 33%) when the average for the OECD countries is a decrease of 10 points. (See
annex 1: Top corporate income tax rates 1995-2009)
The general trend in the European Union is a slight decrease in taxation; there
are countries with high tax levies that are linked with generous social systems like
France but also Denmark and Sweden, and countries which are characterized by a
low tax system such as Ireland. However we must keep in mind that comparisons
between countries, even within an area such as the European Union are tricky
because the corporate tax rates depend on the method of financing the social
protection, the size of their territory (less tax competition for the larger countries
because they have a larger market that make them attractive regardless taxation) .
Thus France has an advantage over Ireland whose territory is smaller.
In addition, each country must also deal with national and European
requirements in terms of public expenditure commitments because of the post-crisis
austerity measures focused more on cutting public spending rather than on higher
tax levies.
However, in the long run, it seems unlikely that such tax diversity is tenable
even if this problem has been emphasized for a long time.
As the E.U integration is at a turning point in its history, states have to choose
between federalism (meaning more integration and a necessary tax harmonization
for all of them) and independence, meaning that E.U construction stucked at that
level. Considering the diversity of European tax policies and the risk of tax

7. 4
competition between them, what are the consequences on foreign investment and
public services?
We will answer this question in three parts: first we will be interested by the
issues of tax competition within de European Union, then about the consequences of
a “Fiscal war” on foreign investments and the public services to finally ask ourselves if
a country absolutely needs to have an attractive tax system to develop its domestic
economy.

8. 5
I/ THE ISSUES OF TAX COMPETITION WITHIN THE EROPEAN UNION
A/ DIVERGENT NATIONAL TAXATION SYSTEMS WITHIN THE EUROPEAN UNION
The evaluation of taxation differentials between countries within the European
Union is relatively complex, especially because every business is a particular case. The
companies being taxed in the country, in which they are established, are subject to
the ordinary taxation system, which in practice, applies to most businesses in this
country, or to special rules according to their activity.
For businesses operating in several Member States it’s necessary to take into
account the parent company countries rules, but also those of the country of
establishment of the subsidiary.
As things stand currently, there is a great heterogeneity of taxation systems among
the Members States of the European Union. The rates vary from 12 % in Ireland to
33% in France and Belgium.
The European Union is still a high tax area. Indeed, in 2012 the overall tax
ratio, that is to say, the total of taxes and social contributions in the twenty-eight
Member States amounted to 39.4 % in the European GDP average: this is fifteen
points over the United States and approximately ten points over Japan.
Nowadays the taxation level in the European Union is high compared to other
developed countries: for instance Russia with an average of 36%, or Canada and
Australia that are below 30%. Regarding the other less developed economies, they
are most of the time characterized by quite low taxation rates.
High European Union tax levels are not new, since the last 50 years the role of
the public sector became more and more important, generating a growth of the tax
ratios in the 70’s, 80’s and 90’s. When the Maastricht Treaty was adopted and after
the Stability and Growth Pact the European Union Members began to adopt some
fiscal consolidation packages. Some countries chose the reduction of public spending;
others chose to increase the taxation rates.
But some countries took advantage of buoyant tax revenues to reduce the tax
burden, through cuts in the personal and corporate income tax as well as in social
contributions.
After the 2008 global economic crisis some effects on growth and then on
income began to appear, even though in the European Union the economic growth
became negative only the following year. The main measures taken by States were on
the reduction of public expenditure. Countries that have chosen to implement cuts in
taxes did it on labor income taxes and, to a smaller extend, on capital.

9. 6
There are deep variations in tax levels in the European Union: the ratio of 2012
tax revenue to GDP was highest in Denmark, Belgium and France (between 45% and
48%); the lowest were recorded in Bulgaria (27.9 % of GDP), Lithuania (27.2 % of
GDP), and Latvia (27.9 % of GDP).
The European Union average top rate of tax on corporate income has remained more
or less stable since 2010. This follows a trend of continual fall rates from 1995 to
2009. The 28 European Union average in 2014 is 22.9 %, compared with 35.0 % in
1995. (See annex 2: Corporate income tax revenues, 1995–2012)
Let’s approach some French and Irish taxation system specifications:
Regarding the French taxation system some specification need to be clarified.
Indeed, in 2012 the tax to GDP ratio in France was 45%, the third highest in 28
European Union and 6% points above the European Union average (39%). Of total
taxes collected in France 54% go to the Social Security Funds, the highest level in
Europe.
The Finance Bill was adopted in December 2013 and the essential changes are,
regarding the corporate taxation, the rate of the notable surcharge which applies to
companies with a high turnover (over 250 million) which has augmented from 5% to
10.7%. As well, a temporary tax of 50% on high wages paid in 2013 and 2014 has
been introduced.
The French tax system is defined by two main characteristics: high nominal
rates of tax and narrow tax bases, due to a large range of tax loopholes. The level of
tax and social security contributions are higher in France than in other European
Union Member States. Also, taxes are concentrated on the most dynamic and most
mobile factors, and these high tax rates on narrow tax bases are generating a very
restricted tax yield.
To illustrate our main point we can rely on the comparison between French
and Irish example. Important differences exist between both countries regarding
their taxation system, but also some differences exist in employment, infrastructure
and education that are key points to answer our issue.
At 28.7% in 2012, the total tax to GDP ratio in Ireland is the sixth lowest in the Union
and the second lowest in the euro area. These rates have been constant in past years.
The taxation structure is characterized by a strong reliance on taxes rather than social
contributions.
The structure of taxation differs considerably from the typical structure: in
Ireland the proportion of social contributions is comparatively low, while the
proportion of direct taxes (particularly income tax) is quite high. As in the majority of
Member States, the largest share of indirect taxes is constituted by VAT receipts,

10. 7
(approximately 56% of total indirect taxes of GPD); taxation of labor has increased by
over 25%, while taxation of consumption and capital has fallen.
Companies resident in Ireland and non-resident companies which carry out a
trade in Ireland through a branch or agency, are, with a small number of specific
exceptions, liable to corporation tax on their taxable profits. The corporation tax rate
of 12.5% is applied to trading profits in all sectors since 1 January 2003. A 25% rate
applies to other passive (non-trading) income.
Ireland was one of the first countries in the world to adopt an FDI-based
development model "As a result of its interaction with the market place for foreign
direct investment IDA-Ireland regularly adjusts its targeting of sectors and companies
while fine-tuning the range of financial incentives on offer to attract inward
investment". (The Celtic Tiger by former Irish Finance Minister and EU Commissioner
Ray Mac Sharry)
Foreign direct investment (FDI) is defined as a business investment aiming at a
long-term relationship, and reflecting a lasting interest and (partial) control by an
entity resident in one economy (foreign direct investor or parent enterprise) in an
enterprise resident in another economy (FDI enterprise or foreign affiliate). FDI
statistics include both the initial investment and all subsequent investment by the
parent enterprise, which can be either in the form of equity capital, reinvested
earnings or intra-company loans. (Eurostat)
The importance of the corporation tax regime in attracting Foreign Direct
Investments inflows to Ireland has led the Irish government to block moves towards
tax harmonization within the EU.
Several studies have attempted to evaluate the implications of such tax
harmonization. Moreover, Irish economists (in particular Patrick Honohan) disagree
as to the importance of the increased FDl flows to the Irish boom of the 90s. Two
opposing theories have emerged in analyzing the "Celtic Tiger" phenomenon. The
first of these (the "delayed convergence" hypothesis), tends to downplay the role of
FDI, while the other, (the "regional boom" perspective) views it as crucial.
Another factor operating in Ireland's favor in the international battle to attract
FDI is that the country remains a relatively low labor cost economy compared to
European Union standards.
The Irish development have been due in part, at least, to an innovation in the
system of wage determination introduced in 1987 which saw wage moderation
purchased via the promise of future cuts in income taxes.
This new "social partnership" approach played a large role in the successful
resolution of the fiscal crisis that had troubled the country throughout much of the

11. 8
80’s. The decision to harmonize at the low 12.5% rate means that Ireland will remain
the state with the lowest effective corporate tax rate in the EU.
The European Union has lost its leading position as the world’s most important
recipient of foreign direct investment (FDI). While the countries of the European
Union accounted for 50% of global FDI inflows in the early 2000s, the share has fallen
to less than 20%. By contrast, the BRIC countries have more than doubled their share
in global FDI inflows since 2007. In 2013, China alone received more FDI inflows than
all European Union countries together.
According to a 2014 Deutsch Bank research “The evolution of FDI activity
across the euro area is very uneven. The highest inflows during the previous two years
were recorded for Spain and Ireland. While Germany and Italy experienced an
increase in FDI activity in 2013, it decreased strongly in France”
Indeed, in 2013, the top FDI destinations in the European Union were Spain, UK and
Ireland, which all received around 15% of the total 240 billion euro inflows.
(See annex 3: The European FDI inflows in 2013)
However, we know that foreign investors are very cautious when entering a
national economy; the macroeconomic stability is a precondition of the arrival and
generally creates an interest in investing in a country. Therefore, the macroeconomic
stability is one of the important determinants of foreign direct investment. It can be
traced through a series of relevant macroeconomic indicators: inflation rate,
unemployment rate, GDP level per capita, external debt, workforce skills, as well as
many other indicators. The important thing to remember is that the foreign investors
take into account several criteria before investing in a foreign market and not only its
taxation system.
As a result, it’s important to admit that there is a real competition between
State Members even if they’re part of the same united economic community. The
European Union is made up of States Members with different characteristics which,
as a whole, have developed production factors as labor or capital. In the case we are
analyzing, France and Ireland, we must realize that taxation becomes a major issue in
the foreign investor’s choice because Europe is more or less homogeneous regarding
the macroeconomic factors we were talking about such as inflation and
unemployment rate, external debt or workforce skills. Some countries make a
difference to attract foreign investors or subsidiaries of multinational companies with
the tax advantages they can offer.
Tax harmonization and tax competition become a European puzzle whose
pieces are the Member States. This issue will continue to be problematic for the
European Union to move towards the European Federalism desired since the creation
of the European Coal and Steel Community.

12. 9
B/ WHAT IS TAX COMPETITION AND WHAT ARE ITS FOUNDATIONS?
Tax competition cannot obviously be reduced simply to the tax burden (See
annex 5: Tax burden in 2011) that may be exerted on businesses in a country or another,
because tax extent is quite complex; because taxes may have as counterpart public
goods such as infrastructure, education or insurance that enhance the business
efficiency and the attractiveness of the territory; and because the decisive tax
parameters vary depending on the type of business or its operations.
However, tax burden is not neutral in the medium to long term on the share of
value added particularly because governments have lost the currency control in the
Eurozone. Taxation is therefore a decisive weapon to increase the competitiveness
and attractiveness of a territory, or to divert the tax base thanks to a growing tax
competition.
According to Jacques Le Cacheux "Tax competition can be defined as a
situation in which the tax decisions of individual states are interdependent and
generate fiscal externalities, source of distortions”. Tax competition is the interactive
governments’ determination of a taxation system in a strategic and uncooperative
manner. In this research paper, we will focus on tax competition between states, but
we must not forget that such competition may apply between regions of the same
nation, or between communities. Indeed, tax competition is a phenomenon that has
existed between all public entities.
Globalization has had a positive effect on the development of tax systems.
Globalization has, however, also had the negative effects of opening up new ways by
which companies and individuals can minimize and avoid taxes and in which
countries can exploit these new opportunities by developing tax policies aimed
primarily at diverting financial and other geographically mobile capital. The economy
mutations have made the countries more open, nowadays we evolve in a more
interdependent and unified world, and above all, we evolve in a world where the
economic agents have greater decision-making spheres and are more mobile. These
actions induce potential distortions in the patterns of trade and investment and
reduce global welfare.
Obviously there are economic agents that are "naturally” mobile such as large
multinational business that will maximize their investments, optimize the location of
its production depending on the taxation conditions offered to them.
The main argument put forward by advocates of tax competition in Europe is
the state autonomy. The autonomy in the sense that each state has the right to
influence the decisions that affect them. Autonomy, in a tax context, is the freedom
to determine their own public budget and their own level of social redistribution: as

13. 10
we have explained so far, regarding this political autonomy, preferences are very
different from one country to another. This autonomy is somehow protected by the
Members State sovereignty to set its own taxation rules. More generally, taxation
rules in one economy are now more likely to have repercussions on other economies.
The key point that emerges within the European Union is that this tax
competition, which falls within a liberal framework, will eventually attain fiscal
autonomy because Member States should be forced to agree in a harmonized
taxation system based against each other interests and not only based in their own
domestic interests, as in the Irish case who gave preferential rates to foreign firms
that allowed more, than to Irish businesses before it was changed by European
directives.
Then, the economic theory provides that such competition becomes a “race to
the bottom”, that is to say, taxes on mobile bases in particular will rapidly decrease.
This reflection leads us to our main issue: whether taxes go down, state revenues will
decrease and, by extension, the public good will too.
However, this statement must be qualified: some countries have moved the
tax burden on capital, which is mobile, on factors that are less mobile like work,
consumption or savings. In other words, these countries were able to protect their
income level at the cost of a potential increased inequality.
So, there are other countries that do not have the financial and administrative
capacity to have an income or VTA tax that pays enough to offset the loss of earnings
due to lower taxation of mobile bases: the result is an income decrease and, forward,
a social redistribution issue.
Why do we tax? Three key goals of taxation have been identified (by Richard A.
and Peggy B. Musgrave, Public Finance in Theory and Practice). First, taxes raise
revenue to finance government spending. Taxing and spending serve a social
distribution function focused on those areas where the market can’t do it as
effectively as the government, including the provision of public goods, competition
policy, etc. Of course, it will often be controversial in how far government
intervention actually serves those purposes. Second, taxes represent an instrument
to redistribute income and wealth to promote the conception of social justice that
has been chosen through the democratic process. Third, taxation rules are
traditionally used to stabilize and smooth the business cycle by tightening or
expansionary policies as the case may.
The context of the 2008 crisis has changed the situation. Because the
European integration, the monetary policy is no longer the short-term policy. The
European treaties as the TSCG (Treaty on Stability, Coordination and Governance)
also called "budget deal” restricts the governments’ flexibility because countries must

14. 11
submit to the European Union and the European Commission their budgetary policies
in order to have their approval.
Since the governments no longer have as many flexibility as before (currency
devaluation for example) to become more attractive and be more competitive, tax
policies remains a solution that can enable Member States to control more or less
their budgetary balance.
According to the OECD there are two types of tax competition:
The “poaching” is a term that has been introduced by the OECD. The
difference between “poaching” and “luring” is the separation between the landlord
of the capital and the capital itself. In that case the owner remains in the country
(where the activity is established) and the money flowing through another account in
a tax haven for example. There is therefore a “poaching” of the tax base from the
residence country to the tax haven where the money flows. Likewise multinationals
send their profits elsewhere while the economic activity takes place in the country of
residence. The tax base “goes for a walk” and is poached by another Member State.
The first example of this type of tax competition are the private (approximately
5800 billion euros hidden in tax heavens) and business investments which flow
through tax heavens such as Switzerland and Luxembourg (Tax ruling)considered as
classic tax heavens.
The second example are the "paper profits" between subsidiaries of the same
company based in countries with more or less advantageous tax systems, in order to
charge for services between the group subsidiaries and shift profits from one
subsidiary to another ( “transfer price”) . It is very hard to verify and is a genuine grey
zone. Paper profits are profits which has been made but not yet realized through
a transaction, such as a stock which has risen in value but is still being held.
For instance Apple takes advantage of the differences between the American
and Irish tax system thanks to a subsidiary registered in Ireland but which is not, for
tax purposes, Irish. This has allowed them to save billions of dollars.
Similarly Google whose profits are diverted to tax havens where they are taxed at
really low percentages. To explain this with significant numbers, in 2012 imports of
Netherlands and Bermuda accounted about 20 % of services imports of Ireland (20%
of Ireland services imports come from the Netherlands and Bermuda)
The “luring” is employed to defined when a government tries to attract the
production base in its territory as they did before in Ireland in the 70's and 80's.

15. 12
Companies and their headquarters move to other countries that can offer to them
taxation benefits. This is particularly the case of the FDI.
To conclude this chapter, I quote the European Commission for whom "tax
competition may strengthen budgetary discipline to the extent that it encourages the
Member States to reduce their public spending and thus helps to sustainably reduce
the overall tax burden”
The introduction of a common tax base wouldn’t be intended to reduce the
taxation level but rather a way to create a corporate taxation method in the
European Union more efficient, more competitive and neutral in budgetary terms.

16. 13
C/ TAX HARMONIZATION VERSUS TAX COMPETITION: THE ISSUE OF THE EUROPEAN FEDERALISM
As we previously mentioned it, European integration evolves since its creation
in 1957. The latest evolution was the TSCG (Treaty on Stability, Coordination and
Governance) ratified in 2012 and which represents the next step towards a
"budgetary federalism" of European Member States.
The term was launched by Jean-Claude Trichet in an interview to Le Monde in May 31
2010: "We now need to have the equivalent of a budgetary federation in terms of
control and monitoring the implementation of public finance policies”
However, in the actual European Union, the redistributive policies of national
governments are threatened by the fiscal competition between them, and this raise
the issue of the interest of an intervention of a supranational government to fight
against the harmful effects of fiscal competition beyond the budgetary federalism.
A few decades ago (in the 90's context of the European Single Market) the
objective of the European Commission was to harmonize national tax policies to
reduce the distortions of competition between Member States. Since the monetary
union has become widespread, the tax competition risk is perceived as a threat to the
States’ budgetary and fiscal sovereignty, because the single currency, which
facilitates the mobility of capital and businesses, may also enhance the risk of tax
competition between States.
Today an uncontrolled tax competition represents a risk for the public finances
of Member States: the State has not only renounced to their monetary sovereignty to
give it to the ECB, but also their public finances are under great pressure because of
the Stability and Growth Pact and or “budget deal” (TSCG). That is why States, unable
to devalue their currencies, could be tempted to take their tax policies as a weapon
to improve their competitive advantage and attract the mobile bases we mentioned:
companies that have subsidiaries or high skilled labor.
To fight against the "harmful” effects of tax competition, several solutions are
possible. These include centralize the fiscal policies, which is the most radical solution
to harmonize taxation rules within the European Union. However, given the diversity
of social models in the European Union, such a solution seems difficult to achieve as
it would imply that rates rise in some regions and decrease in others.
On the one hand, this would have repercussions on the attractiveness and
competitiveness of some territories, and on the other hand, it would have
repercussions on revenues that are needed to finance the public good.
Furthermore, European Union Member States are far from ready to abandon the last
instrument of economic policy available to them, namely the budgetary instrument
as we mentioned it previously.

17. 14
There is already a form of tax harmonization in Europe regarding the VAT.
Europeans have agreed on harmonized rules in the area of indirect taxation. Indeed,
the VAT is part of the acquis communautaire, and two directives (1977 and 2006)
closely codify the VAT regime in European Union Member States, with a minimum
standard rate.
The second area of tax harmonization concerns capital income. In 1990, the
Parent-subsidiary directive tackled the issue of double taxation of repatriated profits
by a mother company from its subsidiaries. Member States are requested either to
exempt repatriated profits, or to deduct taxes already paid by the subsidiaries from
the mother’s tax bill: the objective was to avoid discriminating against foreign
subsidiaries (taxed twice) in relation to domestic firms (taxed only once).
Because tax competition has drawbacks that have been mentioned in the
previous chapter (basically less income and thus degradation of public property
among others), we can imagine that the solution is the European tax harmonization
whose primary purpose would be to limit or eliminate the phenomena of
competition. This suggests that tax harmonization will have the opposite advantages
and disadvantages to those of tax competition.
Obviously tax harmonization would limit the "race to the bottom" and thus it
should increase budgets to afford to provide more goods and services; but it can also,
on the other hand skew how agents make their decisions
Critics of tax harmonization argument that such tax harmonization would
increase overall tax rates throughout Europe; they also argue that the absence of
competition would undermine countries’ opportunities for creative economic reform
and reduce individual freedom. Finally they argue that tax harmonization is not the
only way to fight against tax evasion.
One of the prerogatives of national sovereignty is that tax policies must be a
political decision and from this point of view, the European Union does not yet have
this budget and fiscal sovereignty, and we can legitimately ask if taxpayers would
accept an European tax harmonization.
The concern for national sovereignty that has so far been the heart of the
European project regarding fiscal and budgetary matters seems to be a topic that is
currently discussed and it is likely to increase the years to come, especially after the
economic crisis of 2008. First of all, because Member States are much more vigilant
than before concerning their public finances in the aim to have effective tax
revenues. That is where the growing concern of tax competition comes. Secondly, the
crisis has revealed the need for a greater fiscal integration and European states have
realized the need for greater European integration. Then thirdly, we are evolving
more and more towards a digital economy where information and information

18. 15
transfers are inexpensive and fast; it becomes almost impossible to implement tax
exemption systems through opacity or discretion. For instance, revelation of fraud
and tax evasion make the news.
Finally, the question that arises on both sides of tax harmonization and tax
competition within the European Union is a much larger issue which is the
strengthening of the European integration, and beyond, the question of national
sovereignty of each Member State.
Move towards a European tax harmonization implies that Member States
are willing to concede an important part of their decision-making on tax matters,
which is ultimately a sensitive area given the social implications that this entails, as
we have previously showed it.
Thus one may wonders if the outcome of the European integration could
take place without going through a number of reforms which must affect the
sovereignty of States: can we really move towards a federal Europe without
conceding a share of decisions from national level to the supranational level?

19. 16
II/ THE CONSEQUENCES OF A “FISCAL WAR” ON FOREIGN
INVESTMENTS AND PUBLIC SERVICES WITHIN THE EUROPEAN UNION
A/ WHAT HAPPENS WHEN EUROPEAN COUNTRIES COMPETE ON TAXATION BETWEEN
THEMSELVES?
When examining the European fiscal systems it is helpful to pose a number of
questions as to its economic effects. It should be recognized, however, that it may be
difficult to gather the information necessary to answer these question. Also, although
tax is only one of the factors which may influence investment decisions, governments
may find them in a “prisoner’s dilemma” where they collectively would be better off
by not offering incentives but each feels compelled to offer the incentive to maintain
a competitive business environment.
If the preferential tax system is the primary motivation as to where to locate
an activity, this may indicate that the taxation rules in question are potentially
harmful. It is recognized that in practice it is not always easy for the governments to
evaluate the motivation of investors and that non-tax factors, such as the quality of
the infrastructure, the legal and regulatory framework, labor costs, etc., may also
influence location decisions.
First of all the State autonomy mentioned in the chapter II. B involves to
respect the principles which impose certain constraints on tax competition within the
European Union: each person, capital owner or company is a member of the
geographical zone in which it resides so that everyone must pay taxes in the State to
which they belong.
This principle is not respected because the source taxation rules for companies are
not respected due to the competition and the differences between the tax
regulations between states that allow them to escape.
Tax evasion and tax cuts through these arrangements represent a kind of “free
riding” (Cf. Mancur Olson The Logic of Collective Action: Public Goods and the Theory
of Groups) as these agents are established in a place where they can benefit from
public good, but they’re not paying in return the corresponding levies to benefit from
this public good as the profit is circulating in other geographical areas in order not to
be taxed.
(See annex 4: highest and lowest tax rates in Europe)
Such arrangements takes shape with the multinational companies’ "transfer
pricing" thanks to their subsidiaries in several countries. When these subsidiaries are
working together the goods or services’ transaction price is determined between the
two subsidiaries. The transfer pricing between multinational subsidiaries is an

20. 17
Irish
subsidiary
(Negociation of a
2% tax rate)
Tax
heaven
Apple
product
sold in the
USA
(35% of taxation on
average)
important issue in our modern economy; it represents 60% of the world trade. This is
one of the best tools available to large groups to avoid paying taxes or to reduce
them in the country where they are based. Profits are finally taxed in the country
where the subsidiary is established, often in a tax heaven with an attractive taxation
system. These subsidiaries “buy” goods or services (e.g royalties paid) to a subsidiary
A at very low price and sell them to a subsidiary B at a very high price. So the profit is
made by the subsidiary based in a tax heaven (e.g Luxembourg).
Thus, multinationals contribute less and less to Member States’ tax revenues
where they are economically active thanks to systems such as the transfer pricing. If
tax rates were harmonized such procedures would not be so easy to implement.
The corresponding challenge is that the tax burden necessary to finance the
public good, education, infrastructure, etc., is finally carried by middle class and small
businesses and does not concern large multinational groups that take advantage of
tax competition between European Union countries to minimize their contribution to
the country they belong to.
The most difficult to measure is to know how FDI are diverted from one
country to another according to its specific taxation characteristics in terms of
taxation on one side, and in terms of supply of public goods on the other side. We
can speculate that in Europe taxation plays a more fundamental role than elsewhere
because the European Union Member States are, on the whole, homogeneous;
especially if we compare what we are talking about from the beginning: the countries
with a large territory, and therefore, a potential great market such as France and
Payement
of Royalties
Profits transfer:
Ireland doesn’t tax
money transfers if the
owner is established
abroad

21. 18
Germany, and smaller countries with a comparable level of development who
emphasize on their tax system such as Ireland, Luxembourg and Switzerland.
According to Jacques Le Cacheux whose ideas and documents I have drawn
from for this research paper, tax competition can have damaging consequences. First,
tax competition could lead to a “pricing” of public goods and services, i.e make pay
the different beneficiaries of the public good and services provided by each
government.
This argument refers to another argument often heard in tax competition debates, in
which it’s argue that the choice of business location would be influenced not only by
the lower tax burden, but also by the attractiveness of the public services which this
"contribution" confer.
The heart of problem is social redistribution. But the increasing market
integration and the greater mobility of tax bases make redistribution both more
necessary and more difficult to implement.
Indeed, capital flight and mobile tax bases including large multinationals
companies inevitably tend to create a gap in the redistribution mechanisms,
distinguishing clearly those who benefit from public good, from those who finance it.
Let us recall that the tax exile of the highest income is nothing new and is indirectly
attributable to the increase of the European integration: Switzerland, Monaco, etc.,
have a tradition of receiving “tax exiles". However, it’s also true that European
directives foster the people and capital mobility within the European Union, including
the most qualified people.
Furthermore, a possible increase in the mobility within the European Union
could therefore generate two types of migration: first, those without resources might
be tempted to take up residence in countries where the social benefits are the most
generous, while high-income people would settle in countries offering the best
conditions corporate and income taxation.
This is an even greater risk since, contrary to the public opinion, the European
Union welfare systems are in reality very different particularly in terms of funding,
and the changing demographic structures just as well the aging population , if similar,
are in fact different enough to create funding problems at different moment and
under different conditions.
If, in response to these trends, such mobility behavior of the most mobile
bases became more frequent, thanks to tax competition increasingly enhanced, and
without the control of the European Commission, they inevitably would put into
question the financial solidarity mechanisms that define the financing of public
spending and social protection in all European Union Members Sates.

22. 19
Next, we will examine this “fiscal war” a little deeper through more concrete
examples by comparing the French and Irish cases.

23. 20
B/WHAT ARE THE DIFFERENCES BETWEEN FRANCE AND IRELAND FROM THEIR RESPECTIVE TAX
SYSTEMS? SHOULD THE EUROPEAN UNION CONVERGE TO A TAX HARMONIZATION?
Three European countries were under the microscope of the European
Commission which has launched in June 2014 an investigation about unfair state aid
to three multinationals. These apply to favorable tax arrangements with Apple in
Ireland, Starbucks in Netherlands and Fiat in Luxembourg.
Joaquim Almunia, EU Competition Commissionaire said "When public budgets
are tight and efforts are required from citizens to solve the crisis, it is unacceptable
that multinational groups remain untaxed”
This proves that states are as responsible as multinational companies in the race for
tax competition.
Regarding Ireland, reforms are designed to change its fiscal policy because
Ireland does not want to be seen as a tax haven anymore. Indeed, in the new
financing bill of 2015, Ireland introduced changes and ends the budget austerity
imposed by the European Union. Thus, from early 2015 Ireland definitively bury a tax
system that has allowed so far to multinationals like Google and Apple to withdraw
billions of dollars of corporate tax.
The Minister of Finance Michael Noonan announced the Irish legislation on
corporate taxation reform. This corporation taxation system was criticized since
months by the European Union and the United States. Residence rules will change by
forcing all companies established in the country to become tax resident in Ireland. As
explained in the previous diagram, until now a company could create a subsidiary on
Irish territory while establishing its tax residence in a tax haven.
The new budget also signs the decision to cut taxes on the income of Irish who have
been hit hard by the crisis.
In France, tax evasion would have a cost between 40 and 50 billion in tax
revenue, that is to say, a little more than the corporate tax and almost as much as the
income tax for a year. Similarly the CAC 40 companies pay a lower tax rate than
craftsmen, SMEs, etc. (8 % against 33%)
In December 2013 the Prime Minister launched a major review of tax reform:
it has put in place the foundations of corporate taxation, a working group on
households’ taxation. The government's goal is to make the territory attractive for
businesses, and therefore for capital in the context of uncontrolled liberalization
without control capital flows which have led to a strong tax competition and a “race
to the bottom”: The rate of corporate tax applicable during 1986 was 50% and now it
is about 33 %.
Thus, although the corporate tax in France is higher than in Ireland, it is not enough
to create the necessary tax revenues to public spending.

24. 21
III/ THE FISCAL POLICY DILEMMA: TAX HEAVEN OR THE DOMESTIC
ECONOMY
The effects of the current tax competition between European Union countries
existing since the 2008 crisis have already been seen. This is especially true when
considering multinationals’ tax optimization that went less out of the headlines. In
their case it is not only about establish the profit, but also the headquarters and even
activity in the most attractive countries.
In other words this tax optimization results, in addition to tax losses, a loss of
employment. Some companies did not hesitate a long time to enjoy the benefits
offered by some countries like the United Kingdom or Ireland.
A first example of this is the case of the Italian Fiat Industrial, a former division of Fiat
Group specialized in trucks and industrial vehicles: its leaders openly assume they
moved the headquarters from Turin to the UK attracted by the promise of a
corporate tax lowered to 20 % by 2015.
Similarly, Ireland takes advantage of its tax attractiveness with a rate of 12.5%.
Until now, the country persisted in this policy despite pressure from other Member
States.
Another example is American firm Eaton, a giant in electrical equipment,
which moves from Cleveland, Ohio to Ireland in 2012 by buying its competitor
Cooper. Thus the acquirer group has chosen the city of the group they bought as their
headquarters, considering that Cooper had taken up residence in Ireland in 2009.
Relocate its headquarters in the target company for an acquisition is not a very
common decision, but it is also the case of our third example: the American
pharmaceutical giant Actavis with the acquisition of the Irish Warner Chilcott.
Furthermore, the pharmaceutical industry is a good example because, thanks
to its taxation system, Ireland has become a stronghold in Europe. It became in 20
years a heavyweight in the pharmaceutical industry with 25,000 employees, major
R&D centers, and one of the largest pharmaceutical productions in Europe.
Those are pretty substantial number for a country with a 5 million inhabitants,
without chemistry or medicine tradition. This fiscal dumping creates a real shortfall
for states.
With regard to France, governments chose different measures than its
neighboring countries. One may legitimately ask whether France is losing the “fiscal
war” in terms of tax competitiveness, especially as its neighbors take action for a long
time to increase their attractiveness.

25. 22
In France, the taxation system is complex: the corporate tax base is relatively
small, with many tax loopholes and tax credits which complete it. Thus, despite all,
the corporate taxes in France are not extremely high compared to its European
neighbors, but the posted rates are quite high which may deter potential investors.
Thus, 90% of CAC 40 companies are established in countries with favorable tax
system that allow them a significant tax optimization. Indeed, if we only take into
account tax rates, France will struggle to emerge as a competitive country, nowadays
and probably also later. Given the French’s preference for public spending and
redistribution, rates could remain high compared to many countries, especially new
European Union members.
To reinforce its attractiveness, France has an interest to maintain and enhance
the quality of public services directly or indirectly used by businesses. In this respect,
the real France’s competitors are not eastern or central Europe but around, in the
most advanced countries of Europe.
It would be hard to deny that all the conditions are met to implement the
changes needed in Europe, between the countries that will take advantage on low
rates but with a relatively degraded public good, and those who will apply highest tax
rates but with quality services, infrastructure, etc . France can only be part of the
second kind of countries, but if public services do not resist the comparison with the
best, its mobile bases will seek better fiscal conditions elsewhere.
The introduction of a harmonized tax base is not intended to reduce any level
of taxation but rather a way to create a corporate taxation method in the European
Union more efficient, more competitive and neutral in budgetary terms.

26. 23
CONCLUSION
While the completion of the monetary union in Europe will likely raise to an
increase of tax competition between Member States, particularly on the most mobile
bases that are financial capital and businesses, the available institutional
arrangements in the European Union are obviously insufficient to limit the negative
consequences. Competitive pressure strengthens, in France and in most European
countries, a movement in favor of reducing the tax burden on the most mobile bases.
If this competition would be developed without common rules and constraints
as it has been the case in recent years, it inevitably would lead to reduced
redistributive systems of compulsory levies, to a reduction in social protection and
the impoverishment of national public sectors.
To counter such developments, we should, at least, avoid the harmful tax
competition, by introducing rules that govern and limit the actions of states: we must
go beyond the "code of good conduct" established in 1997.
The Stiglitz-Sen report in 2009 raise, among others, the need to "strengthen
institutional arrangements to improve harmonization and transparency in tax
matters, including the Committee of Experts on International Cooperation in Tax
Matters". Indeed, these organizations cooperate, but they are also competing, a new
question arises: the role of international organizations in the field of taxation is
enough to face the problems arising from international economic integration and
globalization? Do we need a World Tax Organization?
The debates initiated in the United Nations have highlighted the need to develop
policy standards of tax administration and supervision of fiscal matters, the
renunciation of tax havens to harmful tax competition, the role of international
arbitrations, multilateral information exchange procedures, and finally the search for
an international agreement on a mechanism for sharing the profits of multinational
companies between countries.
Tax base harmonization would make tax competition more transparent in that
only tax rates would matter. It would not necessarily lead to an harmonization of
corporate income tax rates since taxes are not the only relevant factor for the
location of companies. Therefore, the European Commission proposed to consolidate
the profit of multinationals within the European Union and apportion it to the
different governments according to a single apportionment formula that would
depend on a combination of turnover, wage bill, number of employees and physical
capital. Each member country would then have the ability to tax its apportioned
share at its own corporate income tax rate.

27. 24
In addition, there are deep philosophy differences between Member States:
France raises its tax rates decreasing the size of the relevant tax bases, continues to
create tax loopholes in several areas that make the fiscal system hard to understand.
Indeed, France is a country that takes incentive measures for businesses such as tax
credits for research and development, or competitiveness tax credit to stimulate the
hiring of new employees, while in other European countries taxation is more
"neutral" and leaves more freedom to businesses after they have paid their taxes.

28. 25
ANNEXES
Annex 1: Top corporate income tax rates 1995-2009

29. 26
Annex 2: Corporate income tax revenues, 1995–2012 (% of GDP, GDP-weighted
average)
Annex 3: The European FDI inflows in 2013

30. 27
Annex 4: The highest and the lowest tax rates in Europe

31. 28
Annex 5: Tax burden in 2011

32. 29
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