The economic consequences of corporate tax rates reductions in the EU: evidence using a computable general equilibrium model

Abstract

In a globalised world where capital is highly mobile governments are eager to attract foreign investors by lowering corporate tax rates. Recent trends points toward a revival of a race to the bottom in corporate income tax (CIT) rates in developed economies. EU countries have been particularly active in this respect given that capital can move freely between member states and that multinationals are in a good position to exploit the multiplicity of tax regimes in the EU to reduce their tax burden. Yet a generalised fall in CIT rate could prove detrimental to tax revenues and trigger increase of other taxes in order to meet fiscal policy objectives. However, a general fall in CIT rates could also spur investment and growth and prove to be a good fiscal policy strategy if, as a result, the corporate tax base increases. The final economic and fiscal impact of a reduction in corporate tax rates is therefore unclear. In this paper we use a CGE model to quantify the macroeconomic consequences of unilateral CIT rates reduction in the EU accounting for each country's characteristics in terms of economic size and tax system and interactions arising between and within countries. We pay special attention to the role played by cross-country spillovers and fiscal strategies aimed at ensuring budget neutrality which represent an important policy constraint at EU level. Uncoordinated tax reforms significantly impact national economies and third-country effects can be significant when large countries implement a CIT rate cut. Small countries are also better-off unilaterally reducing their CIT rate at the expense of other EU countries. We also find that negative spillovers tend to be mitigated when the country reducing its CIT rate restores its budget balance by cutting either public expenditures or social transfers. A larger degree of non-EU capital mobility also tends to reduce the negative spillover effects of unilateral CIT rate reductions.