What Can EU Learn from Canada in Corporate Income Taxation?

Abstract: This paper studies the race to the bottom in corporate income tax rates that has been argued to happen in federal or semi-federal structures and in particular in Canada and the EU, where the highest corporate tax rates have fallen from about 55 percent to approximately 35 percent since the mid 1980’s. Harmonizing tax rates across all the polities forming a common market space is often promoted as a way to avoid this “race to the bottom in taxes” and prevent a possible under provision of public goods. This under provision signifies less income from taxes that is necessary for the government to receive in order to provide schools, health care and public infrastructure. On the other side a decentralized system where jurisdictions set their own rates is often supported because it should lead to increased efficiency in government spending and promote innovative forces in the economy. This empirical paper studies the decentralized system of Canada where the provinces set their own corporate tax rates. It studies if Canada’s system of provincial tax rates could work as a guide for EU when considering harmonization of tax rates. Declines in corporate income tax rates are usually carried through because it is presumed that tax cuts will lead to more Foreign Direct Investment (FDI). Despite the sometimes weak relationship, this study shows that there is race to the bottom in corporate tax rates. However, the race does probably not concern all other taxes which suggests that an under provision of public good will not be a problem. A decentralized system as the one in Canada of corporate tax rates has the advantage of promoting efficiency in government spending through increased competition between jurisdictions.