THE HAGUE, 30/08/06 - Competition between EU countries via tax rates on corporate profits is disadvantageous for most member states. Only countries with high corporate tax rates and large foreign interests, which include the Netherlands, benefit from a budget-neutral reduction in corporate profit tax, according to the Central Planning Bureau (CPB).

The CPB has developed a model for the analysis of corporate tax in the EU. Using this model, it investigated the long-term effects of both unilateral rate cuts (by a single member state) and coordinated changes (by clusters of countries).

A unilateral reduction in the tax rate produces an increase in investments by both domestic and foreign companies. Additionally, this gives internationally operating companies an incentive to shift their fiscal profit to this country. These benefits are however mainly of importance for countries with many internationally operating companies, such as Ireland, Belgium and the Netherlands.

Additionally, a unilateral corporate tax cut increases prosperity in relatively open economies with high corporate tax rates, a category also including the Netherlands, but not in more closed economies with lower rates, such as Greece. Thus, a 5 percentage point cut in corporate tax rates, financed by an increase in the tax on labour, lifts Gross Domestic Product by 0.5 to 1 percent in Belgium, Germany and the Netherlands, but would brake economic growth in countries like Greece and Italy.

A unilateral tax cut can prompt other member states to cut their rates as well. This reaction reduces the envisaged benefits but not the disadvantages of a rate cut, because other taxes are usually raised to pay for the cut. "On balance, a coordinated cut therefore works out to the disadvantage of most EU member states."

Until recently, the Netherlands had a corporate profit tax rate of 34.5 percent, but is cutting this to 25.5 percent. The CPB does not give its verdict on this reduction, but suggests that such a sharp cut is not necessary to take care of competition with other EU countries. "Even if all other member states cut their rates by 10 percentage points, the optimal reaction of open economies like the Netherlands is a reduction in the rate by at most 2 percentage points."

For more closed economies, the incentives for joining in the competitive battle are much smaller again. "Only for countries with large common interests can mutual dovetailing of tax rates, in the form of harmonised or minimum rates, be advantageous. Via this curtailment of the fiscal competitive battle, a race to the bottom in corporate tax rates can be averted."