A common EU approach to corporate taxation

Harry Huizinga, Luc Laeven

09 December 2008



Over the past several decades, there have been many proposals to streamline Europe’s system of corporate income taxation. Recently, the European Commission has favoured the introduction of common European corporate tax base definition for European companies. This common base is to replace the current 27 national tax bases in the EU, at least for the largest firms. The current plan to harmonise the tax base does not go so far as earlier proposals that called for harmonisation of tax rates (see, for instance, the Ruding report, 1992). Corporate tax harmonisation of any kind in Europe is proving to be a hard sell. The present push for a common tax base in the EU is still at a preparatory stage and it remains to be seen whether a tax base definition can be tabled that can count on EU-wide support.

A common EU approach to corporate taxation, of any kind, only makes sense if it yields substantial economic gains to all member states. This, of course, is rather difficult to prove. Proponents of EU-wide reform routinely claim substantial economic benefits of tax reform by way of reduced operating costs for businesses, yielding higher economic growth. Claims of this kind, however, rest on a host of speculative assumptions on how economies may adjust to tax reform. The failure of any significant EU-wide corporate tax policy to be adopted so far could well reflect that estimates of the output and growth gains of tax reform can only be tentative.

A more promising way to making the case for EU-wide tax reform is to point out and quantify some of the economic distortions resulting from the current system with 27 independent corporate tax policies. Indeed, research has pointed out that international tax rate differences tend to affect many of a multinational firms’ economic decisions, for instance in the areas of corporate debt policies and the allocation of accounting profits to different national jurisdictions (see, for example, Hines and Rice, 1994, and Huizinga, Laeven, and Nicodème, 2008). Moreover, international tax rate differences can distort multinational firm location decisions. In particular, taxation may affect the countries where the multinational firm maintains subsidiaries as well as to the country where it chooses to establish its headquarters.

Any research on the impact of taxation on the multinational firm has to be based on an accurate assessment of the tax rates that apply to the firm’s activities internationally. Most studies focus on differences in domestic taxation across countries, with disregard for any international double taxation that arises if the multinational’s parent country imposes tax on the firm’s foreign-source earnings. International double taxation is ignored on the grounds that multinationals in practice can postpone the domestic taxation of foreign source income until these earnings are repatriated, thereby making the domestic taxation of foreign-source income irrelevant.

An empirical study of the impact of taxation on multinational firm location decisions is offered by Devereux and Griffith (1998). These authors are interested to see whether taxation affects the firm’s decision to locate a subsidiary of US multinationals in one of three European countries, particularly France, Germany or the United Kingdom. Information on the international tax system is summarised by the corporate tax rates in the three European countries. The authors find that the probability of subsidiary location in any of the three European countries indeed declines with that country’s corporate tax rate. Thus, the authors establish that corporate taxes in the country of economic activity distort multinational firm location decisions, but they ignore the potentially equally distorting impact of taxation in the firm’s parent country, in this case the US. This latter country taxes the income of its multinational firms on a worldwide basis, potentially affecting subsidiary location decisions.

Recent research by Barrios, Huizinga, Laeven and Nicodème (2008) considers the independent effects of subsidiary-country and parent-country taxation on multinational firm location decisions. The analysis uses data on multinational firms operating in a set of 33 European countries to allow for sufficient variation in both types of taxation. These authors first revisit the question analysed by Devereux and Griffith (1998) regarding the choice of location for foreign subsidiaries. Subsidiary-country and parent-country taxation indeed are shown to independently discourage the location of subsidiaries in a particular country. The size of the estimated impact of both types of taxation on subsidiary location decisions is economically meaningful: a one percentage point increase in the subsidiary-country tax is estimated to reduce the probability of location in that country by 0.63%, while a higher parent-country tax (related to investment in the same subsidiary country) is found to reduce the probability of location by 0.82%. Somewhat surprisingly, the estimated effect of the parent-country tax on subsidiary location decisions is the larger of the two, despite multinational firms’ ability to defer parent-country taxation by reinvesting their earnings abroad.

This apparent paradox can be explained by noting that parent-country taxation of foreign-source income discriminates against the ownership by residents from a particular foreign country. It only applies to owners from a particular parent country, and not to other foreign owners or domestic owners. Discriminatory taxation of this kind puts the affected multinational firms at a clear competitive disadvantage, and apparently multinational firms are keen to avoid the parent-country taxation of foreign source income.

The overall structure of multinational firms is affected by the location choices for new foreign subsidiaries, but also by the international relocations of corporate headquarters, and by the establishments of new multinational firms through cross-border M&As. Each time the multinational firm changes its international structure, it has an incentive to avoid incurring parent-country taxes of foreign-source income. As a result, one expects that the international structure of multinational firms on average is tax efficient in that parent-country taxation of foreign source income is avoided. Barrios et al. (2008) put this tax efficiency hypothesis to the test, and find strong evidence in favour of it: a one percentage point increase in parent country taxation reduces the probability of the parent firm being in that country (rather than in any comparator country) by 4.1%. The headline domestic tax rates in any pair of countries instead are not found to affect the choice of parent firm location between any two countries. Thus, the international double taxation of corporate income by a multinational firm’s parent country appears to have a disproportionately large impact on the organisational structures of multinational firms.

It is unfortunate and economically costly if taxation rather than the availability of skilled labour or the quality of infrastructure determine the headquarter location decisions of multinational firms. New empirical evidence, as discussed, shows that international double taxation has a particularly nefarious impact on subsidiary and parent firm location decisions, suggesting that countries would do well to eliminate their international double taxation of foreign source income. There are two ways to go about this. First, countries that currently tax the foreign-source income of their resident multinationals can switch to exempt such income from taxation. Such a regime switch was proposed in the US by the President’s Advisory Panel on Federal Tax Reform (2005), and the U.K. is studying a similar proposal outlined in HM Treasury (2007). Second, countries can eliminate the international double taxation of foreign-source income collectively by, for instance, EU-wide tax reform. In fact, the introduction of a common tax base in the EU – as currently envisioned by the European Commission – will do the trick. With a common tax base, a major problem will be how to assign the common base for taxation to the participating countries – but at least a multinational’s income will no longer be taxed twice.

Disclaimer: One of the authors is a staff member of the International Monetary Fund. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.


Barrios, Salvador, Harry Huizinga, Luc Laeven, and Gaëtan Nicodème, 2008, International taxation and multinational firm location decisions, CEPR WP 7047.
Hines, James R. and Eric M. Rice, 1994, Fiscal paradise: foreign tax havens and American business, Quarterly Journal of Economics 109, 149-182.
Huizinga, Harry, Luc Laeven and Gaëtan Nicodème, 2008, Capital structure and international debt shifting, Journal of Financial Economics 88, 80-118.
Devereux, Michael P. and Rachel Griffith, 1998, Taxes and the location of production: Evidence from a panel of US multinationals, Journal of Public Economics 68, 335-367.
HM Treasury, 2007, Taxation of the foreign profits of companies, a discussion document, London.
Huizinga, Harry and Johannes Voget, 2008, International taxation and the direction and volume of cross-border M&As, forthcoming in Journal of Finance.
President's Advisory Panel on Federal Tax Reform, 2005, Simple, Fair & Pro-Growth: Proposals to Fix America's Tax System (US Government Printing Office, Washington D.C.).
Ruding report, 1992, Report of the Committee of Independent Experts on Company Taxation, Commission of the European Communities. March 1992.




Topics:  EU policies Taxation

Tags:  multinationals, taxation, corporate tax harmonisation

Professor of Economics and Chairman of the European Banking Centre, Tilburg University

Director-General of the Directorate General Research, European Central Bank and CEPR Research Fellow