The remedy may be worse than the disease; a critical account of The Code of Conduct

Abstract

The Code of Conduct for business taxation may, diametrically opposed to its intention, aggravate tax competition between EU Member States. The reason is that it induces, by restricting harmful tax practices, cuts in generic tax rates that may reduce tax revenue even further. If one presupposes a benevolent utility maximising government, then this worsens the underprovision of public goods. We show within a standard tax competition framework that this scenario is more likely to unfold with a higher upper bound for nondistortionary taxes, a higher responsiveness of mobile capital to tax rate differentials, and a smaller endowment of internationally mobile capital.