The Common Consolidated Corporate Tax Base - An instance of the EU’s Icarus Complex ?

by Victoria Curzon Price, Professor emerita, University of Geneva Member of the Board IREF
The Common Consolidated Corporate Tax Base - An instance of the EU’s Icarus Complex ?

On Wednesday16 March 2011 the EU Commission published a proposal to introduce a Common Consolidated Corporate Tax Base (CCCTB). A few days earlier, on Friday 11 March, the heads of state of the Euro area almost agreed on a « Pact for the Euro » to save the common currency from financial meltdown and come to the rescue of delinquent members (an agreement that subsequently came unstitched). These two events did not appear to be linked, except in timing. But they both illustrated, each in their own way, what one could call the EU’s « Icarus Complex ».
We remember from our school days the wonderful Greek myths : how Prometheus took pity on poor, puny mankind and gave them fire to help them innovate their way out of problems ; how Odysseus got his men to tie his hands to the mast to stop him heeding the Siren calls and making rash decisions ; how Icarus flew too close to the Sun…
We are all aware of the fact that the EU is flying perilously close to the Sun in matters financial, but unfortunately this pattern seems to repeat itself in other areas as well. I propose in this essay to examine the EU’s CCCTB proposal. To choose freely such a boring and technical subject may appear sheer madness, but in fact I seize this opportunity to present the problems raised by this initiative and offer a simple solution.
The essay will be designed as follows : Part I presents a brief historical introduction ; Part II analyses the main issues and presents some implications raised by empirical studies; Part III concludes.

Background to the Common Consolidated Corporate Tax Base
The CCCTB proposal can be traced back a great many years, indeed to the start of the Single Market project of 1985, but it was always held back by the fact that fiscal matters required (and still require) unanimous consent. However, the harmonisation or at least convergence of taxes became a priority for EU leaders after full freedom of capital movements was adopted in 1992. The EU leadership, with support from European multinationals, was (and still is) keen to establish a “level playing field” across the Single European Market, not only in terms of health, safety and environmental standards, but also in fiscal and social matters.
The creation of the Euro added urgency to this question. Since the Euro included members with different economic profiles and levels of economic development, it was deemed necessary to promote greater “convergence” though structural reforms. Hence the “Lisbon Strategy” adopted in 2000 and designed to turn the EU into “the most competitive and dynamic knowledge-based economy in the world” by 2010. Had all Euro zone members taken this project seriously back in 2000, they might have been better prepared for the global financial crisis of 2008.
This was not to be, however, and at the time of writing (2011) the future of the Euro is in doubt and with it, the EU itself. It is therefore almost surreal to note that while the Council of Ministers struggles to create a credible European Stabilisation Fund and save the European Union, the Commission continues doggedly to promote the harmonisation of the European corporate tax base.
The Council of Ministers mandated the Commission in July 1999 to “investigate the impact of differentials in the effective level of corporate taxation in Member States on the location of economic activity and investment and of tax provisions that constitute obstacles to cross-border economic activities in the Internal Market and remedies thereto.” 1 It will be noted that there is a double mandate here. The Council of Ministers is concerned with the misallocation of investment driven by differences in corporate taxation; and it is also aiming to improve the competitiveness of the European Single Market by smoothing things out for cross-border business activities.
The Commission published its initial findings in October 2001 and noted that effective corporate tax differentials among the 15 members were indeed large enough to deserve attention.2 However, mindful of the sensitive nature of the subject, and the sovereignty issues involved, the Commission acknowledged that “The level of taxation in this area is … a matter for Member States to decide, in accordance with the principle of subsidiarity” 3 . For this reason, the Commission opted for a consolidated corporate tax base while leaving Members to determine the applicable national corporate tax rate.
In 2004 a majority of the Council of Ministers meeting as ECOFIN agreed that the Commission should work out the details of this proposal, the result of which was finally published in March 2011 after many expert meetings and consultations.4
The fate of this proposed Council Directive is of course far from decided. It could become the basis for a unanimous agreement; it could become the object of “enhanced cooperation” between consenting Members; or it could simply be shelved.

What are the issues?
Let us start with the question of coverage. It is claimed that multinational European businesses incur unnecessary extra costs in having to comply with 27 different tax systems and that there is a straightforward gain in simplicity and transparency to be reaped from operating under a single tax system, albeit with different tax rates. This uncontroversial observation led to an initial proposal for a Common Corporate Tax Base (CCTB). However, upon examination, this proved too much for Members to accept. It would have implied agreeing on a single corporate tax system, to be applied on a mandatory basis to all firms throughout the EU. What has finally emerged from the negotiating process is very different.
The Common Consolidated Corporate Tax Base (CCCTB) is designed only for firms with a European dimension, and it is not compulsory even for them. The CCCTB would co-exist alongside national corporate tax systems and firms could decide whether to adopt it or not. It is similar in philosophy to the European Corporate Statute, adopted in 2001 and which remains as a possible form of incorporation for European multinationals (to date used by some 700 firms).
This is indeed a modest proposal, and as such has every chance of being adopted. What might be the advantages and disadvantages of the CCCTB? The experts consulted to evaluate the impact of the CCCTB agree, interestingly enough, that there would be very little impact at all. Nor, indeed, does it matter very much, since the CCCTB regime would coexist and therefore compete with 27 national regimes. Firms would soon discover for themselves whether or not there were any gains to be reaped.
Some welfare gains could be expected to flow from greater simplicity and transparency. Firms would benefit from being able to offset losses in one country against profits in another. The greatest gains would come from lightening compliance costs for firms with cross-border activities, whose every in-house transaction is scrutinized by at least two tax authorities each way for transfer pricing irregularities.
Transfer pricing problems would disappear overnight, since the firm would be assessed on EU-wide profits and it would not matter whether the profits arose in a high, or in a low tax country. However, there is never a gain without a pain, and in this case extra costs would be incurred from an “apportionment mechanism”. In other words, the tax payable under the CCCTB would have to be shared out among the different tax jurisdictions according to some kind of key unrelated to profit.
One can immediately see problems here. Taking inspiration from US and Canadian experience in these matters, and after having considered and discarded a system based on value-added (which at first sight seems the most neutral system) the Commission chose to apportion tax revenue according to the “three factor formula”, namely employment, capital assets and sales.
It is not important for the purpose of this essay to compare the possible apportionment formulae in detail. It is enough to note that from different Member States’ perspectives, there are clear winners and losers, with possible dynamic effects. A country where firms habitually experience poor profits would come out a clear winner, and vice versa for countries where firms tend to generate above-average returns. Scaled up to country level, this scheme could set up a curious incentive system: countries would no longer have to be concerned with corporate profits as such, since they could free ride on other countries’ business-friendly regulatory environments – at least in the short run.
In the meantime, the practical application of any apportionment mechanism would be bound to generate uncertainty and disputes with and between tax authorities in as great a proportion as existing transfer pricing problems. There is no ideal, costless solution to the compliance problem.
In the longer run, the continuing existence of different corporate tax rates would do nothing to cope with the main concern of authorities in high tax countries, namely to stop investment flowing from high tax to low tax jurisdictions, since firms would have an incentive to build up “apportionment factors” (i.e. employment, assets) in low-tax areas, leaving only sales in high tax environments.
Indeed, one study concludes that the CCCTB “does not improve economic efficiency” and that “in aggregate European economies would only benefit if the spread of tax burdens is reduced by harmonizing the tax rate as well as the tax base… if tax rates were also harmonized, tax planning would be minimised and capital export neutrality could be realized within the EU”.5
If this is indeed the case, we could say that the mountain has given birth to a mouse – except that in view of the disappointing welfare gains and the fact that the present proposal does nothing to mitigate corporate “tax planning” and “profit shifting”, we can be sure that the EU leadership will return to the issue of harmonisation of corporate tax rates (as suggested by the above quotation).
One assumption of one of the empirical studies commissioned to study the impact of the CCCTB deserves further comment. It concerns the impact on aggregate welfare of corporate tax changes designed to discourage profit shifting. Consider this statement:
“The abolishment of profit shifting opportunities is not a zero-sum game in CORTAX (note: the general equilibrium model used to estimate the impact of proposed reforms). In particular, aggregate welfare in the EU declines by 0.03% of GDP. The reason is that profit shifting allows multinational firms to reduce the overall tax burden on corporate capital. In this way, profit shifting encourages investment, raises GDP and improves welfare… Abolishing profit shifting therefore not only affects the distribution of tax revenues among states, but also raises the tax burden on multinationals and increases aggregate corporate tax revenue.”6
Yes indeed! I could not have put it better. If corporate taxes decline, the return on capital rises, investment and employment increase, GDP rises. So far, so uncontroversial. But if we are really looking for an improvement in the over-all competitiveness of the European Single Market, as the Lisbon Strategy maintains, (including the revised Lisbon Strategy which takes us to 2020), why does the EU not decide on a general lowering of corporate tax rates instead of trying to harmonise them?
Because, I am sure, the Commission will piously repeat that tax rates are none of its business, that it respects the principle of subsidiarity, etc.
But there is a far better way to ensure that corporate tax rates continue their gradual decline from confiscatory levels common in the 1960s and 1970s as they converge naturally to more reasonable levels: simply leave things as they are and let intra-EU and international fiscal competition do its work, without the need for 10 years of hard but almost fruitless work on the part of many experts, academics and bureaucrats.
For sure, corporate tax revenues might gradually decline, but who cares? In exchange investment and employment would grow, unemployment would shrink, overall welfare would improve, overall tax revenues would rise along with generalised prosperity and the European economy would be better placed to meet the many challenges of the future.

The question of tax harmonisation has been on the EU agenda for many years. Its main driver, despite much genuflexion in the direction of reducing compliance costs and increasing transparency, is really a thorough dislike of tax competition on the part of the EU leadership (essentially France and Germany, supported by other high-tax Member States). Yet an attempt to force tax harmonisation on unwilling lower-tax partners (as Germany is shamelessly doing to Ireland in exchange for financial support in the current crisis) is bound to end in tears. Remember Icarus: if you aim too high, you fly too close to the Sun. These countries should consider a perfectly acceptable, less ambitious alternative: namely, the benefits of unilaterally lowering their corporate taxes. They would at a single blow reduce the incentives for profit shifting investment (which they hate), increase their tax base (which they surely would like) and raise their people’s welfare (to which they should not be indifferent).
1. Communication from the Commission to the Council, the European Parliament and The Economic and Social Committee, Towards an Internal Market without tax obstacles : A strategy for providing companies with a consolidated corporate tax base for their EU-wide activites, Brussels, 23.10.2001 COM(2001) 582 final, p.3.
2. Idem.
3. Idem, p.9.
4. Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) (CMM (2011) 121.
5. Bettendorf L., Devereux, M.P., van der Horst, A,., Loretz, S., de Mooij R., « Corporate Tax Harmonization in the EU » , Economic Policy, Vol. 25, issue 63, pp. 537-590, July 2010.
6. Bettendorf, L., van der Horst A., de Mooij R. for CPB Netherlands for Economic Policy Analysis, and Devereux, M. Loretz S., for Exford University Centre for Business Taation, The economic effects of EU-reforms in corporate income tax systems, Study for the European Commission Directorate GEneral for Taxation and Customs Union, October 2009, p. 45.


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