Capital Tax Competition in the European Union: Theory and Evidence from Two Natural Experiments

We investigate the effects of European integration on corporate tax competition. Both economic and monetary integration result in lower transaction costs in �financial markets - by reducing capital controls, red tape and exchange rate uncertainty - and thereby in higher capital mobility. Nevertheless, monetary integration leads to a common pool problem vis-a-vis the shared revenues from issues of the common currency and to higher tax revenue needs due to lower inflation and the defficit constraints embedded in the stability pact. Economic integration may lead to access to better technologies, for the less developed members. It will also lead to more tax-responsive capital and higher user-cost of capital due to the abolition of tariffs. We show that monetary integration leads to lower taxes, while economic integration leads to higher taxes. Furthermore, we �find robust evidence of a race-to-bottom effect. Throughout, we investigate the impact of EU enlargement.