Economic Policy Review ISSN 1313 - 0544

Tax harmonization or tax competition

Author: Metodi V. Metodiev / 20.12.2007
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During 1957 representatives of six European countries signed the Rome agreement, which establishes the European Economic Union. The Rome agreement foresees the elimination of commercial barriers between the participating countries.  Together with that are established unified import duties, as well as common trade policy. To put it shortly, the main objective of the new union was to establish gradually homogeneous common (inter-European) market.

Fifty years after the creation of EC and almost sixteen years after the formation of EU with the Maastricht agreement now the member countries are 27.

The fundamental principals from time of the establishment of EC are the free movement of goods and services, labor and capital - and all that part of the vision of building a unified market.

During all the years of its existence EC succeeded to build a wall between internal Union economic policy and the same policy towards the rest of the World. At present on a European level a strongly protectionist trade policy is carried out and on the other - policy of pressure to implement the ideas of the so called tax harmonization.

Generally, what is understood as tax harmonization could be defined as a process of standardizing the tax policies in the EC, directed against the countries outside the union and/or standardizing the tax policies inside community.  Such policies include the tax rates themselves, as well as the tax regulations, which define the various types of procedures and channels for levying and collection.   

The idea of tax harmonization became again the topic of the day after the joining of the 10 new member-countries to EU.  Some of the old members felt threatened by the fact that the new member countries could offer better and more competitive conditions to business and as a result a large number of companies will swiftly switch to the new situation and could make decisions to move their businesses in a country providing better conditions for realization[1].

Somewhere among the hundreds of different directives and policies of the EU among some economists (predominantly liberal) sneaks the idea for the so called tax competition. Simply said, this is implementing tax policies through market mechanisms, where the tax burden is reduced significantly and reaches an optimal level. Competition effectively defines the working mechanisms of the free market not only for the private companies, but for the governments, which are forced to compete among themselves for "customers" (either corporate or private persons). Competition has the same effect on governments as that on the private businesses. Through the "invisible hand" of the market, the governments will be forced to become more effective and more responsive to the preferences of their "customers". This will guarantee the right of choice of the separate company or individual between the various alternative policies and everybody will have the opportunity to make his objective choice on the basis of personally weighted net utilities whether to live and work in a given country or region. In addition, all of this will lead to implementing more precise budgetary policy in every country and/or region on both parts - revenue and expenditure.

Tax competition is an instrument to encourage people to elect its government based on easy to measure practical criteria and thus to a large extend overcomes "the deficit of democracy", which exists in the contemporary political systems. With his vote for a specific tax policy or disagreement with it and moving the business from one region to another, this will force the governments to face the consequences of the policies implemented, which at the end will save the taxpayer from becoming a victim of the system.   All this is directly related to the fact, that with its introduction the contemporary tax systems are related to coercion. In other words, when the people are paying their taxes voluntarily one could be confident more of them will attempt to optimize the amount of money for them. In order to keep or attract new taxpayers (and) investors, the governments will have to offer innovative and more effective services to their "customers". That is why it is said, that "competition is a very significant process of discovery and unsurpassed machine for growth"[2].


* This article was published for the first time in the newspaper "Dnevnik" on 4th December 2007.


[1] Naturally, we have to note, that a low tax burden is a significant part  of health conditions for doing business in a given country

[2] Pierre Garello