Luxembourg's Tax Tricks and Tax Competition in Europe

Public debate concerning Luxembourg and its tax tricks has focused first and foremost on the individual responsibility of Jean-Claude Juncker. This was perhaps to be expected. Yet there is a danger that the personalisation of the debate will divert attention from the true issue at hand: namely, what tax rules should apply in Europe to ensure fair and efficient taxation?

Luxembourg has granted individual companies preferential tax rates for certain types of revenues, such as foreign brand and patent royalties. While this was not publicly known until recently, it creates three problems. First, the revenues that receive preferential treatment are taxed at very low rates or sometimes not at all. This means that other taxpayers are unfairly disadvantaged. Second, the tax breaks cause other countries to lose tax revenues, even though nothing has changed in real terms, as there is no geographic shift in jobs, production facilities, or revenues sources to Luxembourg. Third, the tax breaks distort competition. Many small and medium-sized companies are too small to take advantage of opportunities in international tax planning. Furthermore, there definitely are multinational companies that do not engage in aggressive tax planning – and they are disadvantaged for it.  One could make the counterargument that the tax tricks used in Luxembourg and other countries do not break any laws. Yet not everything that is legal is also desirable.

What should policy-makers do? Fundamental critics of tax competition have taken the latest revelations concerning Luxembourg as an opportunity to make calls for unified tax rules in Europe, in order to end tax competition. However, unified rules would throw the baby out with the bath water. First of all, the job of creating unified rules would be much more difficult than one might initially suppose. Unified tax rates would not be sufficient. Tax bases would also have to be standardised. In Germany, for example, the Gewerbesteuer, a form of local tax on business, would have to be abolished. That alone might not be a significant loss. Yet the reforms would also have to extend to personal income taxes. Particularly in Germany, many companies are unincorporated, and they would have to abide by the rules enacted at the European level.

Second, unified tax rules would take away an important tool used by nations that are disadvantaged due to their geographical position or other reasons. Formerly the poor house of Europe, Ireland was able to become a dynamic, advanced economy – current problems notwithstanding – thanks to the magnetic effect of low tax rates. 

Third, tax competition helps to prevent excessively high tax rates from being enacted that could endanger jobs and economic growth.

Fourth, unified tax rules would considerably restrict the autonomy of national economic policy. Currently, a debate is taking place in Germany about introducing accelerated depreciation rates to encourage private investment. This would be impossible if harmonised tax rules were in place at the European level.

Thus, instead of trying to abolish tax competition, we should seek to adopt rules that enable fair competition. A key guideline should be the prohibition of double taxation and of the non-taxation of profits. Countries that have low tax rates should offer the same rates to all companies, and not just to select ones. In addition, EU countries should work to better coordinate their double-taxation treaties with non-European states. When individual EU Member States allow interest payments or royalties to flow untaxed to tax havens outside of Europe, this makes undesired tax avoidance easier in all of Europe.