Can Tax Competition Lead to a Race to the Bottom in Europe? A Skeptical View

Abstract

This paper addresses the question of the likelihood of a race to the bottom in a monetary union, like the Euro-zone, that could result from tax competition between countries. This fear of a race to the bottom is used both in the economic literature and the political arena to promote tax harmonization. Using a game theoretical approach with the costs of changing tax policies to analyze the conditions of a race to the bottom, this paper shows that countries may not choose such an extreme strategy. In other words, the extreme case scenario of a race to the bottom is unlikely, and proponents of tax harmonization should base their reasoning upon other assumptions.Monetary union, Economic integration, Tax competition, Tax harmonization, Fiscal competition