A. Undeveloped conditions for tax competition under the political economy of embedded liberalism

The post-war epoch from 1945 until the 1970s is commonly characterised as a period of ‘embedded’Footnote ⁶² or ‘qualified’Footnote ⁶³ liberalism. The political economy of the era involved a commitment to liberalising the international economic order. Yet, developing the cross-border market regime was conditioned on states retaining their national autonomy to carry out each country’s preferred socio-economic model, which allowed, among other things, national market-correcting policies, management of investments and macroeconomic steering.Footnote ⁶⁴ In terms of law, the emerging two-level political structure was devised to strike a balance between liberal and social democratic scripts of transnational law.Footnote ⁶⁵ Rather than embracing a fully liberalised market regime or conferring ambitious market-embedding and other core public powers on international institutions, the emerging order implemented a moderate degree of economic openness, with countries being allowed to resort to capital controls so as not to jeopardise distributive interventions and macroeconomic priorities at home. The balance resembled the domestic settlement of democratic capitalism, under which market-based allocation of resources was supposed to co-exist with democratic choices over the proper distribution of resources.Footnote ⁶⁶

Regionally, embedded liberalism came to inform the functional division of labour between the European Economic Community (EEC) and its Member States. Here, the European pattern followed the more general trajectory of economic globalisation. Roughly speaking, the EEC was to foster aggregate economic growth through establishing the Common Market while Member States were to preserve their relevant autonomy in macroeconomic affairs and in executing distributive measures through social and tax policies, as required by their democratically asserted socio-economic models.Footnote ⁶⁷ European law thus remained open to more market-driven and more socially oriented domestic systems.Footnote ⁶⁸ Besides common agricultural policy and rudimentary forms of macroeconomic coordination, European law was primarily meant to reinforce participation by private economic actors in the Europeanised market system, which was looked on as resulting in improved collective standards of living in Member States. Integration was thus not contrary to but complementary to post-war state reconstruction.Footnote ⁶⁹ In practice, however, carrying out the dual division of governing functions proved difficult. The idea of the European market lent itself to different economic readings. These demanded varying degrees of integration and implied alternative legal arrangements for the Community. Making the European market thus came with the potential of reducing national political discretion in monetary, economic, fiscal and social policy.Footnote ⁷⁰ This became obvious in taxation, too. While tax policy had a place among core national prerogatives, market-making necessitated integrating parallel tax systems. Adaptation to market concerns was not paramount only as regards indirect taxes. Additionally, income taxes – especially on capital and corporate income – were seen as capable of hindering the Common Market.

It might seem that integrating income tax systems through direct legal measures was excluded from the early integration agenda. The Treaty of Rome did not expressly address income taxes, and before the 1990s, no rules on them were issued by the Council.Footnote ⁷¹ There were also expectations that national laws might converge spontaneously as a result of abolishing the most severe trade obstacles, such as customs duties and quantitative restrictions. In this view, the likeness between national policies is not so much an inevitable ex-ante precondition for European trade as its possible ex-post consequence. With a moderate legal framework in place, the Common Market would prove partly self-executing in gradually furthering the conditions of its own functioning. That wage levels, social benefits, interest rates and also taxes might converge due to the ‘interplay of economic forces’ was envisaged in the Spaak Report, in which it was presented as one – but only one – feasible integration mechanism.Footnote ⁷² The idea was endorsed especially by those aiming to avoid any creation of interventionist powers beyond the state. In this vein, Alfred Müller-Armack held that the Common Market itself is capable of yielding the needed tax policy convergence, whatever its precise degree.Footnote ⁷³ On the same note, Ludwig Erhard subscribed to the type of integration that could act as an ‘anonymous force’ pushing economically prudent governments, as he portrayed them, to adopt policies unilaterally but still in line with other countries’ choices.Footnote ⁷⁴ Yet, spontaneous ordering was not advocated as a form of destructive downward policy competition but rather as a way of achieving an institutional environment where the European market could yield full economic gains in the long run. Also, often when the Common Market, in turn, was expected to alter national living standards, these were anticipated to develop upwards, which was due to the mutual rewards expected from dynamic and non-zero-sum economic growth among the Six.Footnote ⁷⁵

In the 1960s, spontaneous ordering of tax systems came by no means to be favoured as the only or even primary integration mechanism. Legal ordering was advocated by the European Commission. In its 1962 action programme, the Commission gave an extensive reading to the Common Market, interpreting it as a market with ‘conditions similar to those of an internal market.’Footnote ⁷⁶ In the programme, while acknowledging the necessity to integrate indirect taxes, the Commission postponed the question of direct taxes and, for the time being, merely referred to their possible spontaneous approximation.Footnote ⁷⁷ Later the same year, the Fiscal and Financial Committee, an expert group authorised by the Commission and chaired by Fritz Neumark, published its report on tax harmonisation. In conformity with its mandate, the committee reflected on integrating taxes for the purpose of ‘establishing the Common Market bringing into being and guaranteeing conditions analogous to those of an internal market’.Footnote ⁷⁸ This permissive interpretation of the Common Market gave rise to a comprehensive plan for approximating taxes by means of law, and the committee proposed ambitious measures with a view to harmonising the core properties of income tax systems.Footnote ⁷⁹ Some years later, many of the committee’s ideas were adopted by the Commission, who drafted an extensive programmeFootnote ⁸⁰ for harmonising income taxes and proposed two (initially stalled) corporate tax directives.Footnote ⁸¹ Even the Commission’s 1975 (failed) proposalFootnote ⁸² for aligning Member States’ corporate tax rates largely followed the Neumark committee’s proposals. In this process, the idea of income tax integration by means of law was formative for the Commission’s work, and it also found support in expert opinion. Rather than competitive forces producing convergence among taxes, law-made similarity among tax systems would precede and usher in ‘the free play of the forces of competition’ between market actors.Footnote ⁸³

Income tax integration by means of law was promoted for the purpose of creating an economically rational order of the Common Market, and the Europeanisation of taxation was chiefly a function of market integration. European law was essentially invoked to bring about territorial neutrality among income tax systems.Footnote ⁸⁴ This entailed, first of all, abolishing the type of tax obstacles that specifically afflict cross-border activities. Secondly, territorial neutrality required harmonising tax systems, which meant bringing national tax structures and rates closer to each other, even if applied to domestic activities only. Ever since the Spaak Report, tax harmonisation had been associated with the conditions of private competition among commodity producers, on the one hand, and capital movements, on the other.Footnote ⁸⁵ Regarding the former, income tax differentials were seen to distort the relatively equal conditions of private competition and cross-border commodity flows, as they would make production costs differ among producers located in different countries. Regarding the latter, tax system disparities were perceived as artificial incentives capable of influencing market participants’ locational decisions and of prompting ‘“abnormal” capital movements, ie movements springing from other than the traditional economic and financial considerations.’Footnote ⁸⁶ Taxes were also not to function as deterrents that ‘artificially divert or impede the necessary mobility’ of factors of production.Footnote ⁸⁷ By functioning as false incentives (ie triggering unwanted capital movements) and deterrents (ie inhibiting economically warranted investments), taxes would lead to ‘a misallocation of capital’Footnote ⁸⁸ and undermine the aggregate economic gains rationalising the integration process. Income taxes were thus construed as costs on production, and harmonising them by means of European law was to ensure they do not make for disproportionate competitive advantages among producers and obstruct the functioning of the cross-border market mechanism. In this role, harmonisation was to protect the genuinely economic sphere from arbitrage and guarantee that arbitrary legal factors do not pervert the process of price formation.

Harmonising taxes by means of law and for the sake of fostering competition among private actors was cast in a positive light in particular by Hans von der Groeben, acting as a European Commissioner from 1958 until 1970. As a second-generation ordoliberal, von der Groeben was much more sanguine about European integration than original ordoliberals.Footnote ⁸⁹ Many ordoliberals were wary of the integration process because, as a form of regional co-operation, it lacked a truly global reach. They also feared that the emerging European Communities would assume the powers of political intervention and thus replicate national practices of economic planning.Footnote ⁹⁰ Still, ordoliberal doubters of European integration, such as Wilhelm Röpke, held that the co-existence of national tax systems, oscillating in line with volatile political preferences, produces arbitrary cost factors capable of distorting international competition among private actors. Concern was especially pronounced under developed post-war tax systems, harnessed for various political purposes of economic steering, industrial policy and social protection.Footnote ⁹¹ This was also precisely von der Groeben’s concern. But where many ordoliberals refrained from considering European law as a feasible way out of this predicament, von der Groeben adopted the core ordoliberal premise of law as a means of ensuring the existence of private competition and entrusted European law with the task of ‘normalising’ the institutional conditions of competition across the Common Market.Footnote ⁹² Tax harmonisation by means of law was to be operationalised exactly to achieve this goal. In von der Groeben’s view, tax harmonisation was not to give rise to European powers of redistribution or dirigiste planning but merely to establish a rational and law-made framework for the European system of market economy and private competition.Footnote ⁹³

In spite of the push for income tax integration, national room for political manoeuvre in using taxes for social, budgetary, economic and fiscal policy purposes was not to be compromised, as frequently articulated in harmonisation initiatives.Footnote ⁹⁴ Rather than full unification, harmonisation entailed that Member States preserve the characteristic features of their tax systems, stemming from national fiscal traditions, and continue to harness taxes for the political goals of their domestic democratic choice.Footnote ⁹⁵ Upon proposing harmonisation of corporate taxes in 1975, the Commission still acknowledged taxation as an important domestic ‘instrument for achieving economic and social objectives, whether they affect structures or current economic trends. Until these objectives can be defined and achieved at Community level, the authorities will have to ensure that harmonization in no way hampers the use of taxation as an instrument of national policy.’Footnote ⁹⁶ The roughly shared aspiration was to reconcile control over domestic socio-economic orders with the rational organisation of the Common Market. Yet, as regards income taxes, agreement on the balance between these two aspects proved unattainable and political bargaining yielded no results before the 1990s.Footnote ⁹⁷ In the post-war European state, income taxes had transformed into such an essential means of shaping social and economic circumstances that political discretion in exercising the power to tax was not to be risked.

The eventual lack of income tax integration resulted in a number of cross-border trade obstacles being removed but income tax policy being kept at national discretion. Did this outcome, then, come down to what Fritz W. Scharpf has influentially characterised as the asymmetric structure of the European polity, a structure conducive to tax competition?Footnote ⁹⁸ And was it perhaps a straightforward product of actors and ideas favouring tax competition? Some observers have indeed seen the EEC as ‘the closest realization of the neoliberal ideal of a federalized tax regime’, which neoliberal intellectuals ‘must have been happy with’.Footnote ⁹⁹ Regarding early integration, this interpretation seems to be ahistorical. As already mentioned, non-harmonisation was associated with the need to preserve national capacities to actually use the power to tax for democratically warranted purposes. Therefore, non-harmonisation was anything but validated by reference to triggering disciplinary forces of policy competition. For many, the reverse side of non-harmonisation was not a loss but rather preservation of policy autonomy. Interpreting the non-centralised system of income taxation as a sign of endorsement for tax competition would amount to an anachronistic reading. This is so for three key reasons.

The first reason is that in the 1960s capital was not unequivocally considered as transnationally mobile, either legally or factually, as it has been since the 1980s. In Article 67 of the Treaty of Rome, liberalisation of capital movements pointed primarily to allowing payments necessary for other market freedoms to materialise. In spite of this humble formulation, more extensive liberalisation certainly had its proponents and two directives were issued to liberalise many key and also tax-relevant capital movements, although in a qualified fashion.Footnote ¹⁰⁰ Beyond these, however, liberalisation of the European capital market was paralysed until the late 1970s.Footnote ¹⁰¹ As a result, preconditions for mobile finance remained relatively scarce and free movement of capital featured as an ‘aspirational goal’.Footnote ¹⁰² Even when income tax harmonisation was invoked to prevent unwished-for capital movements, as analysed above, capital movements were often regarded as a conceivable outcome of future integration and the hypothetical completion of capital market union.Footnote ¹⁰³ Because footloose capital, capable of reacting rapidly to national tax system differences, was not widely experienced as a critical phenomenon, it was not perceived as catalysing destructive policy competition. In the absence of full capital mobility, harmonisation was not a vital task.Footnote ¹⁰⁴ Hence, even if mobility of capital should not be underestimated, its effect on national policy autonomy was considered more modest than in later decades. Limited capital mobility was also not only a cause that reduced fear of tax competition. Rather, it partly resulted from the precise need to create a legal framework able to inhibit policy competition, and – as one of the core elements of embedded liberalism – limited capital mobility was devised to protect national policy autonomy.Footnote ¹⁰⁵

The second reason seen to lessen the pressures of tax competition was weak macroeconomic integration. To be sure, in the Commission’s 1962 action programme, ambitious plans emerged for European macroeconomic coordination.Footnote ¹⁰⁶ Later, the expert group chaired by Pierre Werner envisaged a thorough Europeanisation of monetary policy, which would deprive Member States of their ability to manage the external value of money (exchange rate) within the Common Market.Footnote ¹⁰⁷ In spite of the push towards common monetary policy, advocated chiefly as a way to complete the European market, macroeconomic integration remained at a rudimentary level.Footnote ¹⁰⁸ As a result, Member States continued to have at their disposal monetary policy instruments by which to manage the balance of payments or, in language having become more common later, competitiveness. Even in the Bretton Woods monetary system of fixed exchange rates, currency devaluation remained an instrument of adjusting the competitive position of a national economy. Because of the possibility of devaluation, taxation and fiscal policy were not the only significant means of tuning domestic producers’ international competitiveness. Since taxation was not overburdened as a factor of competitiveness, tax systems could better resist possible competitive pressures. Admittedly, managing the exchange rate was not an ideal measure to restore competitiveness; if the problem was a particular industrial sector with specific competitive disadvantages, devaluation was an imprecise cure.Footnote ¹⁰⁹

The third reason why tax competition did not come out as a critical concern was lack of a developed ideational framework, that is, conceptual lenses through which policymakers perceive and interpret the political and economic reality. To be sure, the idea of tax competition was not unfamiliar around the time of early integration. Many of its basic properties and also its uneasy relationship with democracy had already been recognised in scholarly work.Footnote ¹¹⁰ Further, from the mid-1950s onwards, early formalised models of tax competition, mainly for national federal polities, were gradually produced in economics.Footnote ¹¹¹ Yet it was only in the 1980s that literature on the preconditions and consequences of international tax competition burgeoned and became more analytical.Footnote ¹¹² In particular, scholars began to examine tax competition as capable of creating serious downward convergence among national tax systemsFootnote ¹¹³ and of distorting proper distribution of the tax burden between migrant and immobile taxpayers.Footnote ¹¹⁴ These issues were also analysed rigorously in the context of European integration.Footnote ¹¹⁵ States were also increasingly portrayed as actors aiming to attract foreign capital and not merely protecting their existing domestic industries. The idea of a tax competition framework rapidly translated into policymakers’ ideational frame through which to review the outcomes of non-centralised and, alternatively, harmonised taxation. But, before the 1980s, the conceptual framework for perceiving governments as rival actors introducing competitive tax incentives in order to become a lucrative territory for migrant capital was not fully developed and thus did not permeate early political discourse on tax integration. In part, this related to real-world circumstances: due to restrained capital mobility under embedded liberalism, the political economic reality did not feed into a powerful imagery of tax competition. Ideas matter, but their policy-shaping power depends on their historical elaborateness and the support they command from various knowledge producers.

To recapitulate, in early integration, non-harmonisation of Member States’ income tax systems is not to be taken as displaying endorsement of tax competition that could pre-empt national democratic choices. Relatively modest capital mobility, an array of domestic macroeconomic policy options and lack of a fully developed idea of states as devoted competitive agents meant that tax competition was not a critical concern in discourses on income tax integration. When present, worries related merely to the distorting effects of tax concessions on the conditions of competition among private actors, but not on social, macroeconomic or fiscal deterioration.Footnote ¹¹⁶ Given the firm mandate of politics for ordering social and economic conditions under post-war democratic capitalism, more articulate anxieties about tax competition should have ensued, had the dynamics of competition been experienced as undermining national autonomy to organise the domestic economy. In fact, the viability of national welfare regimes was essential in validating the pursuit of international economic openness, which was prima facie seen as a precarious enterprise, especially due to the spectre of the inter-war economic collapse.Footnote ¹¹⁷ Achievability of national variants of a mixed economy was a condition of legitimate integration, but rather than by harmonising income taxes, this achievability was confirmed through confined and trade-oriented market integration. The roughly symmetric structure of European law was thus brought about by combining moderate economic integration with national income tax autonomy. Even if one correctly assumes a dormant tension between European market-making and national tax autonomy, it was only towards the 1990s that this unease came to be seen as developing into a fully-fledged clash. The Hayekian neoliberal federation capable of exhausting interventionist political energies and domesticating other core public powers was still waiting to be invented.

B. The ascent of tax competition under the neoliberal reconfiguration of political economy

By the early 1990s, policy competition and institutional competitiveness had solidified themselves as commanding policy ideas and established a largely new frame of political reason.Footnote ¹¹⁸ They had come to shape not only domestic law-making but also discourses on transnational governing arrangements, such as the Europeanisation of income tax law. For their ascent, a number of institutional and ideational transformations were crucial. Several of these transpired as (often delayed and protracted) responses to the 1970s economic downturn that preluded the end of post-war economic expansion. As they were pivotal for global political economic reorientation, they were critical for the EU.

The first change was the continuous deepening of the global market regime and in particular the legal and factual mobility of capital, corporations and intra-firm activities.Footnote ¹¹⁹ The 1980s ‘relaunch’ of European integration and the new Single Market conception were regional forms of this development.Footnote ¹²⁰ Second, under non-harmonisation of income tax systems, the gradual enlargement of the Community widened tax policy gaps between Member States and reinforced their significance as potential incentives for territorially migrant capital.Footnote ¹²¹ Also, with more countries on board, it became more difficult to reduce these differences. This was unquestionably so due to the unanimity rule. Even though the Single European Act (SEA) largely abandoned the procedurally demanding constraint of unanimous decision-making in the Council, taxes remained within the scope of the unanimity rule,Footnote ¹²² as some countries feared that easy Europeanisation would moderate future tax competition and bar domestic choices in terms of lowering fiscal burdens.Footnote ¹²³ Furthermore, as many market-making norms could be adopted by a qualified majority but tax norms required unanimity, furthering economic mobility was disproportionately easier than adopting tax rules capable of balancing market integration.Footnote ¹²⁴ The outcome of this asymmetry became evident immediately under the SEA. As capital movements were liberalised in 1988, their liberalisation was to be counterbalanced with a minimum tax on interest accruing from mobile financial assets (such as deposits, loans and securities), but the Commission’s draft for such a taxFootnote ¹²⁵ was rejected. Third, beyond the political mode of decision-making, the European Court of Justice (the Court, the ECJ) expanded the interpretation of the four economic freedoms, which had a liberalising effect on overall economic mobility. This aggravated European institutional asymmetries, since the Court’s liberalising reading of the economic freedoms was difficult to balance by political decisions, and especially so when the latter required unanimity.Footnote ¹²⁶ Fourth, as definite steps to Economic and Monetary Union (EMU) were fixed in the Treaty of Maastricht, Member States were destined to lose essential monetary policy powers, especially the capacity to manage the exchange rate.Footnote ¹²⁷ This reduced the ways in which countries could influence their international competitive performance and, eventually, underlined taxation as a means by which governments could still engineer their competitiveness, which itself was now perceived as a core factor heralding the economic fate of a nation. In addition, the euro as a common currency could boost the internationalisation of finance and the mobility of competed-for capital. The asymmetric structure of the EMU meant that monetary policy was centralised, whereas fiscal policy, especially income taxation, continued to be organised in the form of competitive federalism.Footnote ¹²⁸

Besides developments in European institutional arrangements, two political economic changes that unfolded across countries should be highlighted. The first of these was the enhanced importance of foreign capital. International finance and inward foreign direct investment were portrayed extremely positively and cast as vital sources of national economic prosperity, for which reason they turned into salient targets for policy competition.Footnote ¹²⁹ Rather than merely ensuring domestic firms’ market shares at home and export competitiveness, governments tailored their laws to serve as incentives for inward investments. Simultaneously with cross-border financial flows becoming a key resource for private economy (and indirectly for generating tax receipts and employment), they grew pivotal for governments in a more direct manner. Especially from the 1980s until the early 1990s, rates of sovereign indebtedness soared as public spending was increasingly financed through public debt. In order to qualify as credible borrowers, countries set out to attune their policies to assumed creditor preferences.Footnote ¹³⁰ Increased capital mobility thus came with a widespread yearning for foreign finance. Second, the protracted economic crises of the 1970s had discredited social democratic and Keynesian priorities and empowered neoliberal economic wisdom.Footnote ¹³¹ Neoliberals interpreted the 1970s crises to have resulted from overgenerous welfare state provision and political intervention in the economy, and they saw that the crises merely corroborated the unsustainability of the post-war market-embedding regime.Footnote ¹³² This interpretation became powerful among policymakers. Governments across countries began to adopt more neoliberal recipes of supply-side economics, which advised not to manage aggregate demand but to incentivise capital circulation and economic initiative by retrenching taxes and other public interventions. The post-war tax systems suffered a legitimacy loss and could not but be reformed.Footnote ¹³³ Restructuring tax and other policies could thus be advocated on the grounds of economic efficiency and irrespective of competitive pressures. Yet the neoliberal mentality had an effect on competitiveness, too. Under the diffusion of neoliberal ideas, governments were ready to craft policies more competitive through downward adjustments. A distrust of market-embedding systems meant that competitive rules were easier to enforce, as alternative policy options were losing currency.

Simultaneously with political economic changes, the idea of policy competition emerged powerfully among knowledge producers. International bodies, such as World Economic Forum (formerly known as the European Management Forum) and World Competitiveness Center, introduced competitiveness scoreboards, with individual countries setting up their own competitiveness councils.Footnote ¹³⁴ These bodies produced indicators by means of which policymakers audited governing systems and set out to improve competitive performance in the eyes of migrant capital and regime-shoppers. This involved a novel rationality or episteme through which the law was (re)viewed, perhaps most correctly called a calculus of competitiveness. Laws were increasingly subject to economistic evaluation, which had its origins particularly in the law and economics movement and in various management theories.Footnote ¹³⁵ In addition, in formal-mathematical economics, use of policy competition as an analytical framework burgeoned. Furthermore, a growing body of political scientists and legal scholars perceived the global market as a regime where states act as rival agents under economic exigencies and spontaneous market dynamics. The global economy, introduced to prompt competition among private actors, was seen as turning into a catalyst for competition among governments. The notion of the ‘competition state’ was only a terminological peak in this widespread pattern of thought.Footnote ¹³⁶ Since the European market was also felt as attaining primacy over national policy autonomy and undermining Member States’ effective political control over their socio-economic systems, European embedded liberalism was experienced as becoming replaced with ‘subversive liberalism’.Footnote ¹³⁷ Under subversive liberalism, Member States were losing their factual capacities to govern while those same powers were not being reconstituted through European law. This resulted in a regulatory void and the evaporation of political authority.Footnote ¹³⁸ Importantly, policy competition extended far beyond innovation, technology and education policy. Since taxes were easily construed as burdens on economic activity and therefore as undermining countries’ cost-competitiveness, scaling down tax levels and the redistributive functions of tax systems seemed like a sacrosanct path to greater competitive performance. Once non-competitive fiscal alternatives had been pre-empted, genuine democratic choice at home had become hollow.Footnote ¹³⁹ Under the hegemony of the competitiveness imperative, the co-existence of national policy autonomy and the reconfigured European market was widely interpreted as running into a fatal clash.

Ascending ideas and practices of competitiveness created a context in which the question of European law as a framework for tax competition could not but come into play. Those relying on social democratic political premises insisted that erosion of political capacities be corrected through European rules, capable of mitigating the democratic and social damage caused by the competitive order. Rather than reversing the trend of internationalising the economy, those with a social democratic inclination welcomed enhanced economic mobility across borders.Footnote ¹⁴⁰ But at the same time they began to look on European and more global institutions as feasible forms of enabling effective exercise of core public powers and governing market externalities, in symmetry with the newly created economic openness.Footnote ¹⁴¹ For them, it seemed that ‘welfare-state functions can be maintained at their previous level only if they are transferred from the nation-state to larger political entities’.Footnote ¹⁴² Hence, the interventionist political philosophy of policy competition was endorsed. In contrast, those relying on neoliberal political premises celebrated the fact that Europe was facing its ‘once-in-history constitutional opportunity’ of creating a federal union with a fully liberal economic constitution that would unleash spontaneous market forces, avert all market-embedding leanings and, through the workings of policy competition, rein in national policy choices.Footnote ¹⁴³ For them, European law was a means by which to expedite neoliberal choices at home. Their alternative was the evolutionist political philosophy of policy competition. Hence, Europe stood at the crossroads of interventionist and evolutionist modes of integration. In the context of policy competition, Gerard Radnitzky, hailing from the Hayekian neoliberal faction, envisaged that ‘[m]ore than by anything else the form of life prevalent in the post-1992 Europe will be determined by the placement of the frontier between evolutionary competition and constructivistic dirigisme.’Footnote ¹⁴⁴ It was at this ideational crossroads that European responses to tax competition were expected to emerge.

European tax competition policy began to take shape in the early 1990s. The European Commission forecast that completing the European market would multiply capital flows triggered by tax system differences and that it would fuel tax competition. This could have adverse budgetary and distributive consequences in Member States.Footnote ¹⁴⁵ Yet these concerns remained clearly overshadowed by market-making considerations, amplified by the need to execute the new Single Market programme. The Commission came to regard income tax integration chiefly as an instrument for creating the European market, but not for preventing the deleterious effects of market integration or consolidating national capacity to tax. Furthermore, carrying out the Single Market was different from establishing the Common Market in the initial phase of integration. This was evident as regards the modes of integration. The Commission largely withdrew from its earlier attempts to neutralise institutional differences by means of legal harmonisation. The approach was in accordance with the broader premises of minimal harmonisation endorsed in the Single Market programme.Footnote ¹⁴⁶ As a result, European tax law-making was confined to abolishing only the most distortive obstacles to cross-border market activities.Footnote ¹⁴⁷ In this vein, the Council adopted its first income tax directives,Footnote ¹⁴⁸ one postponing taxation of cross-border corporate restructuringFootnote ¹⁴⁹ and another removing taxes on intra-firm cross-border profit distribution.Footnote ¹⁵⁰ Hence, in implementing the Single Market, European law was harnessed to enhance intra-Community economic mobility, and legal harmonisation as a means of neutralising the conditions of private competition or of reining in tax competition was largely off the table.

Forsaking legal harmonisation did not entail total disregard for equal institutional conditions of private competition. They were still pursued, but the means were now different from legal equalisation. In this context, the Commission cast tax competition as a potential mechanism for eradicating institutional differences; the interplay of market forces and competition among states was envisaged as leading to spontaneous alignment of tax systems.Footnote ¹⁵¹ In contrast to earlier efforts at harmonising taxes by means of law and political agreement, harmonisation was entrusted to take place in an open-ended process of policy competition. Tax competition was thus seen as capable of realising the essential goals of integration. In this process, the function of law was different from what it was in the earlier ‘integration through tax harmonisation’Footnote ¹⁵² approach. The role of law was now to foster cross-border economic mobility, which enabled policy competition as a mechanism of spontaneous integration. Viewing tax competition as an integration mechanism was in line with the Commission’s ‘realistic’ and ‘pragmatic’ approach to tax integration, cherishing subsidiarity and Member States’ formal fiscal autonomy as fully as possible.Footnote ¹⁵³ As stated by Christiane Scrivener, the Commissioner responsible for taxes, ‘[w]hat we need is a minimum approximation consistent with the abolition of fiscal frontiers by January 1, 1993. After that date, market forces will play their role in the single market.’Footnote ¹⁵⁴ In harmonisation, European law occupied a secondary role in comparison to the power of market forces. Rather than political intervention, spontaneous evolution occurred as the proper framework for producing equal conditions for competition among market actors.Footnote ¹⁵⁵ The self-restrained approach to legal harmonisation became evident in the Commission’s response to the report drafted by the committee of tax experts, chaired by Onno Ruding. The committee shared the Commission’s idea of policy competition as a positive means of fostering fiscal convergence and the functioning of the European market. Beyond that, it acknowledged drawbacks resulting from tax competition and proposed far-reaching harmonisation of corporate tax rates and bases.Footnote ¹⁵⁶ Yet the Commission and national representatives maintained that harmonising fiscal conditions would surpass the acceptable boundaries of the new harmonisation approach, for which reason the Commission was unwilling to follow the committee’s recommendations.Footnote ¹⁵⁷ Rather, through spontaneous dynamics of tax competition, harmonisation could purport to proceed in an apolitical fashion, as the shape of national tax systems could be portrayed as unfolding independently from intrusive European political decisions. More than its possibly subversive effects, the concern was that tax competition, as an adjunct of market integration, might not generate enough convergence for the needs of completing the Single Market.

In the mid-1990s, tax competition was turning into a more complex issue and ceased to be a mere constructive instrument of spontaneous market integration. It emerged as a source of dysfunctionalities for national fiscal systems and domestic public policies. Besides fostering the Single Market and enhancing the effectiveness of domestic employment policies, curbing tax competition became one of the three key ideas rationalising the Europeanisation of taxation.Footnote ¹⁵⁸ In this respect, the view of Jacques Santer’s CommissionFootnote ¹⁵⁹ (in office 1995–1999), in which Mario Monti took a shepherd’s role in taxation issues, merits being quoted at some length:

Beyond the traditional Community concern for inefficient and abnormal circulation of resources across countries, the Commission cast tax competition as a constraint on national political autonomy. Competition was capable of undermining governments’ capacities to collect revenues and of leading to ‘fiscal degradation’Footnote ¹⁶⁰ ; distorting fair patterns of distribution; and, by pushing Member States to shift the tax burden from mobile tax bases to labour, hindering domestic attempts to raise the rate of employment. The rising tax burden on labour figured as the most critical concern. More than for distributive reasons, regulation of tax competition was urged to ensure labour market efficiency and ‘employment-intensive’ growth. The need to boost employment framed Community policies on virtually all fronts,Footnote ¹⁶¹ and also in the context of taxation it was declared that ‘[f]ighting unemployment is the biggest challenge facing the Community today.’Footnote ¹⁶² It was repeatedly argued that counteracting tax competition would help reduce non-wage labour costs and that these tax cuts would, through their dynamic effects, facilitate employment. Here, the key predicament was that tax competition generated an economically adverse allocation of the burden between mobile tax bases and labour. Tax competition was thus claimed to be structurally tilted towards specific socio-economic effects.

Due to its disruptive effects, tax competition could not be left to structure public policies without European political interference. With some hindsight, the Commission held that a ‘deliberate and limited pooling of fiscal sovereignty by individual Member States to their collective decision-making would have avoided an unconscious surrender of sovereignty by each of them to market forces, in a field that should remain the prerogative of public policy.’Footnote ¹⁶³ Tax competition featured not only as a disciplinary force vis-à-vis public authority but something that itself had to be regulated.Footnote ¹⁶⁴ In order to prevent excessive erosion of the power to tax, the evolutionist paradigm of integration was to be complemented with interventionist properties. In a sense, European integration was becoming a reflexive process: should carrying out the Community’s primary goals prompt secondary consequences, they were to be corrected through European law.Footnote ¹⁶⁵ The promise of transnational law was now partly seen in its capacity to restore, at the European level, the political autonomy that Member States had lost in the absence of European intervention.

As political reflections on a regulatory response to tax competition unfolded, the Commission kept on repeating the unwished-for consequences of competition for domestic public policies. Yet itFootnote ¹⁶⁶ painted tax competition in more complimentary terms than it did when it initiated the process:

While in the early 1990s the beneficial effects of tax competition were associated with spontaneous fiscal convergence rationalising the functioning of the Single Market, they were now linked to domestic public policies – in a sense that goes beyond European market-making reasoning. Also, unlike roughly a year before, these effects were also characterised favourably. Tax competition was envisaged as creating downward pressure on taxation and public spending. Therefore, as an instrument of fiscal discipline, it could support the Commission’s sharpening effort to push Member States onto the track of ‘a durable reduction in the overall tax burden’,Footnote ¹⁶⁷ also regarded as conducive to competitiveness. The view was in line with neoliberal ideas gaining political relevance in the 1990s and stressing the function of policy competition as a wished-for disciplinary mechanism on the exercise of political powers.Footnote ¹⁶⁸ But the new perception also aligned with a further idea about the capacity of policy competition to benefit individuals by optimising national governing systems and making them more efficient. This idea developed especially powerfully from the late 1980s onwards among German economists and later-generation ordoliberals, who borrowed Hayek’s view of competition among individuals as a ‘discovery procedure’ and applied it to competition among legal systems.Footnote ¹⁶⁹ They assigned an epistemic function to policy competition and depicted it essentially as a means of knowledge generation and policy learning.Footnote ¹⁷⁰ Faced with fiscal necessities, governments are forced to make policy innovations and resort to alternative governing arrangements. Rather than moderation of competition through legal harmonisation, the constitutional type of order with economic mobility and non-centralised tax policy is promoted. For validating the legal framework of spontaneous integration, the idea that competition produces forced policy innovation was crucial, as spontaneous integration could be conveyed as something other than a force with mere subversive and constraining effects.

The perceived benefits notwithstanding, one of the detrimental effects of tax competition was that it hampered the structural rationalisation of tax systems. Rationalisation is what is referred to as ‘broadening the tax base and lowering the rates.’Footnote ¹⁷¹ This normative model of taxation involves broad tax bases – the inclusive scope of the power to tax – with low tax rates – the relatively restrained intensity of the power to tax. The model has its recent ideational and policy-relevant origin in post-1970s economic theory, and it was enforced through neoliberal tax reforms abounding since the mid-1980s.Footnote ¹⁷² It was a reaction to the post-war interventionist tax systems, which steered the economy and investments through tax policies. In the politics of taxation, the model urged ‘a shift from market-regulating to market-conforming policy rules’,Footnote ¹⁷³ equated to tax neutrality. A neutral tax system abstains from interfering with market-based allocation of capital and, so goes the assumption, results in effective allocation of investments – both within and across borders. Since tax competition is prone to distort the distribution of tax burdens among mobile and immobile taxpayers, it violates tax system neutrality. Therefore, work against tax competition was not so much concerned with safeguarding Member States’ revenue-raising capacities as ensuring that countries are able to introduce system structures that align with normative ideas characterising neoliberal tax reforms and conform to rational organisation of the market economy.Footnote ¹⁷⁴

Spontaneous integration was claimed to come with both benefits and pitfalls, and the European political response to tax competition was to strike a balance between them. For the chosen regulatory approach, neutrality of taxation became the formative principle. The idea of neutrality framed the core separation between ‘harmful’ and ‘fair’ tax competition, which gradually obtained its distinct conceptual edifice in the course of drafting European policy.Footnote ¹⁷⁵ The former equates to targeted tax competition employing atypical tax base structures and favouring particular economic activities, whereas the latter refers to general tax competition resorting to low but equal tax rates or generally applicable tax base exemptions for similar economic actors.Footnote ¹⁷⁶ Hence, it was harmful competition that violated neutral tax treatment. Yet neutrality of taxation is a formal criterion requiring equal treatment and leaving the material characteristics of that treatment unaddressed.Footnote ¹⁷⁷ Due to the narrow understanding of what qualified as harmful tax competition, substantive legal standards for taxation remained absent. Beyond factually discriminatory taxes, it was in Member States’ discretion as to how to harness their tax systems for policy competition. In fact, in 2001, the Commission asserted that any rational system of European corporate taxation ought to tackle harmful modes of tax competition while, at the same time, ‘must not hinder the possibility of general tax competition’.Footnote ¹⁷⁸ In this view, tax base rules necessitated some degree of coordination but spontaneous integration of tax rates, including their downward trend, was generally advocated. Tax rate-based competition was thus becoming a confirmed normative doctrine in European multi-level governance of taxation.

The extent to which neutrality and the harmful mode of tax competition dominated the European approach becomes evident in the actual regulatory response. This took place chiefly on two institutional fronts. The first was the Code of Conduct for Business Taxation, which was a political commitment to relinquish tax structures or special tax rates that result in abnormally low taxation when compared to the ordinary tax burden in the country in question.Footnote ¹⁷⁹ The second was application of the European state aid rules to tax systems. Like the Code of Conduct, the state aid rules were also put into practice so as to address atypical tax structures and special tax rates that were, as required by constitutional state aid criteria, selective and diverged from ordinary tax structures in the country in question.Footnote ¹⁸⁰ Both regulatory responses thus addressed structural anomalies within a given national system. Rather than governing dysfunctionalities arising from gaps between separate tax systems, responses were concerned with system-internal consistency. For this reason, it has been suggested that the rules adopted did not abolish tax competition. Instead, because of the narrow interpretation of what counted as harmful, they merely reshaped national competitive practices and advised Member States to harness general and non-discriminatory corporate tax rates in pursuing competitive advantage.Footnote ¹⁸¹ For countries having already adopted a lowering of the general corporate tax rate as their strategy, the European normative choice merely confirmed the acceptability of their existing course of action.Footnote ¹⁸² Regulation of tax competition did not thus fully address the imbalance between corporate and labour taxation, which was initially seen as one of the predicaments raised by tax competition. In fact, given that general tax rate cuts, as well as generally applicable tax base exemptions not discriminating between taxpayers, lower the burden across the whole corporate sector, shifting competition to general rates and structures might aggravate the imbalance between corporate and labour taxation. By avoiding substantive legal standards and interference with tax rates, tax coordination was able to purport to proceed as a predominantly apolitical path of integration.

The confined understanding of what makes tax competition harmful crucially limited European regulation of spontaneous fiscal integration. In fact, the premise of non-discriminatory treatment between corporate market actors, which regulation boiled down to, demonstrates how intimately the European response was – in terms of its eventual legal settlement – designed to urge a neutral cross-border market regime; rather than safeguarding Member States’ fiscal capacity, it ensured equal treatment of market actors. The response aligns accurately with the Commission’s credo that ‘a properly functioning Single Market remains overriding priority for Community action in the field of taxation’.Footnote ¹⁸³ It has indeed been suggested that the political narrative of tax competition was devised as a mere persuasive means of pushing forward long-stalled income tax integration whose core rationale remained none other than the traditional aspiration of integrating taxes for the sake of creating a European market.Footnote ¹⁸⁴ Furthermore, simultaneously with the hegemonic national imperative that an individual country must secure its competitiveness vis-à-vis other countries, a powerful regional imperative emerged that Europe, as a distinct economic space, must ensure its competitive performance vis-à-vis other regions.Footnote ¹⁸⁵ To some extent, this set the boundaries for what was deemed possible in regulating tax competition. It was repeatedly asserted that minimum tax rates across the EU might trigger the outflow of capital to third countries. Hence, curing the malady stemming from countries’ obsession with competitiveness was partly thwarted by the same obsession that gave birth to the very malaise, albeit it was now Europe’s collective competitiveness that appeared imperative.

The Commission stated in 1990 that, in the absence of political income tax integration but with a commitment to complete the Single Market, the ECJ ought to ensure that economic mobility is not frustrated by income taxes and that it should do so by interpreting the economic freedoms.Footnote ¹⁸⁶ The Court had begun to do precisely that in the 1980s,Footnote ¹⁸⁷ and during the 1990s, the number of rulings only soared. By applying the economic freedoms, the Court enforces the market-making aspect of EU law and provides for tax competition. To what extent it does so depends on how broadly it interprets the economic freedoms and the justifications available for countries to defend their existing laws.Footnote ¹⁸⁸ Importantly, the Court came to adopt an extensive reading of the freedoms, as it also let arrangements with hardly any economic substance fall within their scope. The economic freedoms thus came to protect practices used to yield advantage from legal differences. In company law, this happened famously in the Centros case.Footnote ¹⁸⁹ In the income tax context, the Court ruled that operations with only nominal economic substance are also covered by the economic freedoms and only ‘wholly artificial arrangements’ are considered as tax avoidance.Footnote ¹⁹⁰ The Court thus rendered the economic freedoms instrumental in forum shopping and made room for artificial measures that can be operationalised for reaping benefits from tax system differences. Given that corporate profits can be shifted across borders by means that have almost no economic substance but yet major tax effects, they react quickly to competitive incentives introduced by governments. At the same time, the Court did not counteract tax competition in any meaningful way. This, of course, was not surprising, as the Court was systemically unsuited to doing so, which is so for two core reasons. First, the Court was programmed to implement economic liberties but not to oblige states to tax; at best, it allowed states to maintain the fiscal measures they had already adopted at their own initiative.Footnote ¹⁹¹ Had the Court been enforcing secondary legislation obliging Member States to use their power to tax, things would have been different. But this type of income tax legislation remained lacking and the Court focused on implementing economic liberties. Second, the Court operated in the mode of negative integration; it ruled whether domestic and cross-border situations were treated equally but did not prescribe any materially determined standard that governments were to follow in amending their tax laws. Hence, the Court remained far from an organ for legal harmonisation. Even though the Court can obviously recalibrate its lines of interpretation, it cannot revoke its structural reins and basic operative logic.Footnote ¹⁹²

To recapitulate, unlike in the earlier phase of integration, in the 1990s the idea of tax competition became formative for the discourse on income tax integration. Tax competition was considered as affecting both the Single Market and Member States’ domestic policies. Through its harmonising effect, spontaneous integration was expected to align the institutional conditions of competition among private actors. Through its disciplinary effect, it was further hoped to exert downward pressure on the tax burden. In spite of its possible wished-for effects, harmful tax competition was nonetheless claimed to distort private competition among enterprises, and it was this concern that eventually fashioned the European legal response. Elements of interventionist integration were endorsed, but since they addressed only country-internal tax system inconsistencies, their harmonising effect remained modest. Rather than asserting positively determined substantive standards on tax treatment, European rules focused on preventing discriminatory treatment of market actors and sporadically prohibiting specific national arrangements, thereby leaving the proper material treatment open.Footnote ¹⁹³ They thus largely retained national legislatures’ formal legal autonomy in taxation. To be sure, examined against its own eventual premises, work against tax competition was not a complete failure.Footnote ¹⁹⁴ However, since the idea of tax competition was construed on the basis of liberal market-making premises, the European regulatory response did not result in the kind of market-correcting norms that the social democratic advocates of European integration had been waiting to emerge and that could have mitigated what was experienced as the eroding balance between capital and labour in taxation. If Commissioner Scrivener’s statement that after 1992 ‘market forces will play their role’Footnote ¹⁹⁵ had been a normative preference in 1989, it could be restated as a relatively valid empirical account ten years later. The degree of income tax harmonisation did not match enhanced economic mobility, and their asymmetry began to resemble the order of competitive fiscal federalism, familiar from neoliberal reveries. At the crossroads of evolutionist and interventionist philosophies of policy competition, the latter road was not taken in any profound sense.

C. Post-neoliberal globalisation and the European rescue of national public finances?

The first decade of the 21^st century witnessed lethargy in the political integration of income taxes. While governments carried on with devising their tax – and especially corporate tax – systems with an internalised commitment to competitiveness, new ways of governing tax competition did not come into view at the European level. The EU politics of tax competition had found its course in the late 1990s, with championing non-discriminatory competition on general tax rates and structures remaining at its core. Even upon proposing a harmonised corporate tax base and a mechanism for allocating taxable profits among countries in 2011, the Commission insisted that ‘[f]air competition on tax rates is to be encouraged’.Footnote ¹⁹⁶ If tax system differences seriously hindered anything, it was the market-rational functioning of the European Market. Indeed, from 2001 onwards, reflections on income tax integration took place almost exclusively in the context of implementing the Internal Market.Footnote ¹⁹⁷ Furthermore, the Internal Market itself was to execute the Lisbon agenda that aspired to turn the EU into ‘the most competitive and dynamic knowledge-based economy in the world’,Footnote ¹⁹⁸ which also set a framework for income tax policy.Footnote ¹⁹⁹ Beyond competitiveness, the Commission chiefly advised Member States to render tax systems more efficient and rational with the customary recipe of broadening tax bases and lowering tax rates, which aligned with the inherited wisdom of tax system neutrality.Footnote ²⁰⁰ During this period, disregarding systemic problems inherent in the co-existence of tax systems amounted to ‘an extraordinary conspiracy of silence among the European policy-making community’.Footnote ²⁰¹ At the same time, a certain tension was building up in European tax policy. On the one hand, taxation was supportive of cutting budget deficits and sovereign debt, which was exactly what countries were expected to do in order to comply with the EMU rules on sound public finances. On the other hand, and with a fair dose of economistic confidence, lowering taxes was experienced as having dynamic effects that would contribute to economic growth, investments and employment, with the reignited dynamics of the private economy consolidating public finances, too. In the 2010s, this tension became crystal clear.

As the 2010s were setting in, even hesitant scholars began to believe that, in the field of international tax, a shift from market-oriented and neoliberal globalisation ‘to what we can only describe at this point, the beginning of the process, as a post-neoliberal globalization’Footnote ²⁰² might be in the making. The post-financial crisis era seemed to validate the prediction, leading political scientists to declare that the 2010s ‘changed the scene of global tax governance in dramatic ways’,Footnote ²⁰³ ‘provoked a period of rapid, radical and unpredictable co-operation’Footnote ²⁰⁴ and resulted in ‘a sea change in EU policy’.Footnote ²⁰⁵ The celebrated change did not emanate from nothing. The 2007 economic crisis that erupted as a financial or subprime credit crisis gradually developed into a Eurozone sovereign debt crisis, which called for political responses capable of fortifying national public finances, wherein enhancing the revenue-raising capacity of taxation could feature as a key measure. Moreover, letting national income tax systems develop on their own devices and under competitive pressures seemed contradictory as the crisis sparked off cries for European fiscal capacity and for EU taxes financing the EU’s own activities and public goods produced at the European level.Footnote ²⁰⁶ Furthermore, the simultaneity of trenchant austerity policies and several leaks disclosing how corporations and capital owners avoid taxes spurred political frustration in the public, which politicised the usually inconspicuous matters of international tax.Footnote ²⁰⁷ Relatedly, non-governmental organisations gained a footing in the tax discourse,Footnote ²⁰⁸ which balanced the policy-shaping power of experts who had traditionally exerted a major influence on international tax rules.Footnote ²⁰⁹ This politicisation also took place among norm-makers, who began to forge ahead with new international rules. While this was the case in the EU,Footnote ²¹⁰ the initiative often came from the group of G20 countries and the OECD. Due to this widely shared commitment among countries, the new rules could be adopted globally and therefore without critical loss of regional competitiveness. As to the feasibility of the reform, even the business sector was not entirely against multilateral tax norms. Because some type of tax reform was clearly gaining momentum, the corporate sector bemoaned the likelihood that unilateral measures would yield disparate and more stringent rules than coordinated efforts were likely to produce.Footnote ²¹¹ But has the claimed transformation of the international tax regime come with a meaningful change in the European politics of tax competition and in the core ideas animating it? The answer is mixed and depends on where the change is expected to occur.

The first place to look for change is the EMU context. The Eurozone crisis was addressed through various new (but also old) forms of European economic governance, such as the Macroeconomic Imbalance Procedure and the European Semester, which essentially related to the EMU edifice and were harnessed to engender financial and fiscal stability. Member States’ budgets and economic policies, including tax, were increasingly reviewed against (everchanging) European standards of stability and perceived macroeconomic prudentiality. In this form of economic governance, tax systems were chiefly expected to foster investment, growth, employment, social mobility, tax compliance and overall competitiveness.Footnote ²¹² The vague prescription for governments was to lower taxes on labour and shift the burden onto other immobile bases, such as consumption and property ownership.Footnote ²¹³ Tax reforms were to ‘trigger private investment’ and to turn the domestic ‘socio-economic structure into a more competitive one’, which was regarded as particularly imperative for states with a high sovereign debt load and subject to debt-cutting programmes.Footnote ²¹⁴ These loose maxims were familiar from the two preceding decades; tax systems had to become competitive and conducive to employment, economic initiative and efficient circulation of private capital. In the tradition of economistic reasoning, the suggested reforms were portrayed as translating into dynamic effects that increase the volume of economic activity and, in turn, consolidate public finances. Hence, the new mode of economic governance chiefly reinvigorated existing economic wisdom by giving it a more formal and institutionalised status. Yet, countries receiving financial assistance from the European Financial Stabilisation Mechanism, the European Financial Stability Facility or the European Stability Mechanism, were also subject to measures involving obligations to rely more extensively on taxation (for instance, by increasing the progressivity of income taxation).Footnote ²¹⁵ Then again, Ireland’s low corporate tax rate, being one of the notorious hallmarks of tax competition in Europe, was not addressed in the country’s fiscal consolidation programme,Footnote ²¹⁶ as ‘the retention of the 12.5 per cent corporation tax rate was a red line for the Irish authorities.’Footnote ²¹⁷ For governing tax competition, the new mode of economic governance indeed remained rather futile. For Member States whose public finances and macroeconomic trends roughly abided by European threshold values, the new economic governance did not become imperative, for which reason it had a varied impact in different countries. For its different imprint across countries – also between Eurozone countries and those outside the euro – the new mode of economic governance had limited capacity to steer and in particular to harmonise national tax systems.Footnote ²¹⁸ Overall, outright interference with tax systems remained relatively modest. But by effectively ruling out many policy options, the new mode of economic governance pushed countries, both discursively and formally, to maintain their competitiveness, as this was one of the economically orthodox policy courses that countries had at their disposal, and taxes continued to play a pivotal role in fostering competitiveness.

In analysing the broad trajectories of the EU’s post-financial crisis political economy, scholars have (rightly) stressed the legal instruments used in governing macroeconomic stability in the EMU framework. Yet, regarding European tax policy, this emphasis presents a myopic picture, since ideas on tax competition have been critically re-articulated outside EMU procedures, although this took place rather slowly when compared to reactions within the EMU framework. Especially since 2015, this has happened by the straightforward method of drafting directives, and a flood of directive proposals has been emanating from the Commission.Footnote ²¹⁹ If the new modes of macroeconomic governance have focused on making national tax systems competitive and compliant with perceived dynamic laws of private economy, directive proposals have involved measures supportive of Member States asserting their power to tax in positive terms, that is, by imposing taxes. Rather than only assuming dynamic-behavioural effects resulting from scaling down taxation, drafting directives has underlined the legal design of tax systems. Still, even beyond the EMU context, the change in the politics of tax competition has been somewhat camouflaged by how the new agenda has been staged. Pursuing tax reform has chiefly been framed as a response to taxpayers’ aggressive tax planning, tax avoidance and tax evasion practices. The cause for reform has thus been construed as the problem of states struggling to exercise the power to tax, with taxpayers doing their best to circumvent that power. On the surface level, the focus has shifted from externalities between governments to perverted interaction between the state and private economic actors, which has made tax competition seem like a mere secondary issue. Yet I would venture to suggest that policy ideas on tax competition have anything but escaped significant re-articulation. This is partly so because taxpayers’ tax avoidance practices rely on virtual or imaginary capital flows, and these capital movements are something over which governments have increasingly learned to compete. Moreover, as post-financial crisis tax policy ideas developed, they ceased to deal with mere virtual capital flows. In so doing, they partly abandoned the premise that tax competition is harmful only when relating to artificial or virtual capital flows.

The second place, then, to look for change in the European politics of tax competition is the traditional law-making context of drafting directives. European post-financial crisis tax policy has been rather manifold, but regarding tax competition it can be meaningfully divided into three approaches. First, rules have been introduced to reduce tax authorities’ epistemic deficits. They have been part of the process that Commissioner Pierre Moscovici proclaimed as the European tax ‘transparency revolution’.Footnote ²²⁰ For instance, financial institutions must report asset holdings to tax administrations more openly,Footnote ²²¹ corporate actors must present their tax-related figures to tax collectors on a country-by-country basis,Footnote ²²² and tax officials must inform foreign treasuries about secretly issued domestic advance tax rulings.Footnote ²²³ Rules on transparency and administrative sharing of information do not create new obligations to impose and pay taxes. By establishing an administrative right to know and see clearly, they merely empower states to factually enforce existing tax obligations, instituted and due by a national statute already in force. Since transparency rules are not creative of the power to tax, they have been regarded as a liberal and lax form of governing tax competition.Footnote ²²⁴ Moreover, as knowledge-enabling norms avoid setting substantive standards on how to tax, they do not harmonise national tax systems. Yet, at the same time, they are not totally insignificant in regulating tax competition. Many countries’ competitive policies of low or non-taxation are predicated on taxpayers’ auxiliary chance not to report taxable income to their home-country exchequers. While reducing tax secrecy directly addresses tax avoidance or tax evasion, it indirectly mitigates adoption of predatory tax schemes. In fact, scholars have suggested that the recent OECD transparency rules, implemented in the EU as well, have genuinely helped governments tap financial flows, which has reversed the downward trend in tax rates on capital income across borders.Footnote ²²⁵ In the Commission’s revised view, then, tax competition should be not only ‘fair’ but also more pronouncedly ‘transparent’.Footnote ²²⁶ Even though countries remain broadly allowed to compete on taxes, pressures to do so should not derive from taxpayers’ chances to conceal their true affairs. Once again, disapproving tax competition remained qualified, and for some time curing the epistemic deficit through transparency rules was to determine ‘everything that we [the Commission] wish to accomplish on the tax policy front over the next few years.’Footnote ²²⁷

The second approach to regulating tax competition has aimed at introducing substantive tax rules and is therefore more significant than transparency-oriented norms. The approach has been captured in the somewhat phraseological imperative of corporate profits being ‘taxed where economic activities take place and value is created’,Footnote ²²⁸ stressing a real and meaningful territorial connection between taxation and the economy. Recent developments in economic reality have distorted this connection and enabled corporations to sever the link between the territory of income formation and that of taxation.Footnote ²²⁹ Taxpayers have become able to shift profits to countries offering low taxation but having no actual role in income generation. This has corrupted the idea of economic allegiance between the taxpayer and the state, which obtained an influential formulation by a group of economists in 1923Footnote ²³⁰ and has been formative for the international order of corporate taxation. In the OECD’s view, ‘low taxation is not per se a cause of concern, but it becomes so when it is associated with practices that artificially segregate taxable income from the activities that generate it’.Footnote ²³¹ The key criterion for harmful tax behaviour is artificiality, which refers to capital movements without actual economic substance. These capital movements lack business logic and seek to reap benefits solely from disparities between legal orders. They are routinely organised in the form of intra-firm payments and often carried out with fictitious (non-market) prices.Footnote ²³² The burgeoning of artificial capital movements has cut off the territory of economic value creation from the territory of tax obligations. While in the early phase of integration it was held possible that abnormal capital flows might result from the free movement of capital, they were now seen as having reached their full actuality.

The use of artificial capital movements lurks at the core of taxpayers’ tax planning and avoidance practices. They are also something over which governments increasingly compete, which has not escaped the eye of international organisations. The International Monetary Fund (IMF) acknowledged that ‘tax competition is driven at least as much by profit-shifting concerns, including in relation to “[tax] havens”, as by the desire to attract real investments.’Footnote ²³³ Governments tailor tax policies to incentivise inward – and to disincentivise outward – artificial capital flows. These types of policy choices are characteristic of contemporary tax competition, conceptualised as ‘virtual tax competition’.Footnote ²³⁴ This insight has critically shaped the post-financial crisis regulation of tax competition. It has also been formative in terms of the Commission’s approach, which has stressed the complementary nature of tax avoidance and tax competition. In drafting anti-tax competition policies, the Commission has noted that ‘the nature and form of tax competition have changed substantially over the past two decades’Footnote ²³⁵ and that governments ‘compete for highly mobile tax bases, notably accounting profits as well as income related to intangible assets[.] At the same time, multinational companies use these structures as well as unintended mismatches between countries [sic] tax systems to decrease their overall tax payments.’Footnote ²³⁶ In fact, ‘[i]ntense competition for mobile tax bases has created new opportunities for aggressive tax planning’.Footnote ²³⁷ It appeared that rival governments both inspire and rely on corporations’ quasi-economic behaviour, and the harmfulness of tax competition became attributed to competition over artificial capital flows. The legal geography of corporate taxation had indeed developed into something like a virtual reality. In spite of the original grand aspiration of the European project to create a market order with a genuinely economic logic, the market-making law of the EU has essentially enabled the emergence of artificial capital movements and the virtual aspects of contemporary capitalism.

The second approach to tax competition chiefly addresses the mismatch between the territory of economic value creation and that of taxation, aiming at ‘[r]e-establishing the link between taxation and where economic activity takes place’.Footnote ²³⁸ In short, re-pairing the economy and taxation should happen by fixing which corporate activities a Member State ought to tax. The substantive rules would specify the economic activities that should be taken into account in calculating a national tax base. European law would thus involve a positive construction of the tax base. For instance, the Anti-tax-avoidance DirectiveFootnote ²³⁹ enhanced resistance by tax systems to non-economic capital flows by obliging states to disregard some of these flows in calculating tax bases, resulting in non-recognition of artificial arrangements (such as in the cases of excessive intra-firm interest payments and economically passive intermediate entities). The directive was essentially organised upon the idea of refusing to acknowledge mere virtual arrangements.Footnote ²⁴⁰ The Commission also proposedFootnote ²⁴¹ a (later abandonedFootnote ²⁴² ) full harmonisation of the corporate tax base, as uniformity would mitigate capital flows that exploit disparities between national rules on which items to tax. Still, even with a common European tax base in existence, states could continue to compete through differences in statutory tax rates. Indeed, resorting to statutory rates is what the Commission had for long encouraged Member States to do and what had also been allowed by the European politics of tax competition. Partly because of tax rate competition, there was a need for rules on allocating taxable profits between countries, that is, determining which Member State is entitled to tax profits. Rules of distribution were proposed (without success) both for business activities in generalFootnote ²⁴³ and for the digitalised economy in particular.Footnote ²⁴⁴ The allocation rules employed criteria such as the number of employees and customers and the volume of sales, as these were considered genuinely economic and value-creating factors in a relevant material sense. Yet, even if a share of the tax base was allocated to a Member State, it remained allowed to decide its tax rate or indeed whether to apply any corporate tax at all. Rather than regulating tax rates, the significance of rates in competition was to be reduced indirectly by adopting proper criteria for territorial economic allegiance. The rules were intended to articulate the criteria for evaluating where firms generate value and conduct their business. In such a role, they would re-create the territorial congruence between tax law and economic reality, which by now was establishing itself as a key imperative for the politics of tax competition and rearticulating the limits of acceptable competition.

The third approach to tax competition gained currency at the turn of the 2020s. Because the rules for extensive tax base harmonisation and allocation of taxable profits between countries had not found political endorsement, new alternatives were sought. The concerns behind this approach were relatively similar to those that framed the second approach. The diagnosis was that not only tax base structures, but also statutory tax rates, were extensively used in competition over tax revenues. As revenue needs were building up due to the Covid-19 pandemic, Germany and France proposed that European recovery measures should ensure ‘effective minimum taxation’ of corporations.Footnote ²⁴⁵ While not proposing a minimum corporate tax as part of the Next Generation EU recovery package, in 2021 the Commission did proposeFootnote ²⁴⁶ a 15 per cent minimum effective tax rate on corporate profits of large companies. This was once again in line with an initiative and pre-drafted rules emanating from the OECD,Footnote ²⁴⁷ the idea being ‘to put a floor on excessive tax competition between jurisdictions.’Footnote ²⁴⁸ The proposal was initially opposed by Poland and Hungary, as a result of which some countries announced their intentions to implement the tax unilaterally.Footnote ²⁴⁹ Yet, with some amendments, the Council endorsed the proposal in 2022.Footnote ²⁵⁰ The directive marks a departure from any recent tax competition policy and especially from the Commission’s previous blueprints, which have constantly underlined that ‘harmonisation of corporate tax rates is not part of th[e] agenda.’Footnote ²⁵¹ The regulation of tax competition now came to involve affirmative and quantified construction of public authority, that is, the minimum level of exercising the power to tax. While the second approach imposed substantively defined and positive standards on tax base architecture, it did not require Member States to exercise the power to tax; the decision on actually making use of that prerogative remained at the national political discretion. This is what the third approach aims to change.

While the minimum corporate tax rate initiative has been prepared in the discursive framework of ensuring taxation where value is created, it follows a significantly different logic. This becomes evident, for instance, in how the directive’s main rule, the income inclusion rule, operates. In the case of multinational enterprises, the rule requires that minimum taxation be executed at the level of a group’s parent company and collected by the parent’s home country. This happens by adding to the parent’s taxable income a foreign subsidiary’s profits initially taxed by the latter’s home country but with a rate falling below the 15 per cent minimum. Inclusion takes place irrespective of whether the income to be included has been generated abroad as a result of genuine economic activities, although this effect is moderated by the so-called ‘substance-based income exclusion’, which reduces the amount of taxable income with reference to real-economic factors.Footnote ²⁵² The minimum tax rate rule cannot therefore be fully inferred from the normative assumption that taxation must take place where value is created, as the country responsible for taxation may be a country without any actual or material connection to the subsidiary’s value creation. Indeed, the minimum rate approach is ‘more concerned with whether companies pay tax than where they pay it.’Footnote ²⁵³ In such a role, the said rule is meaningful in governing tax competition, as the power to tax is exercised at the minimum intensity irrespective of how corporate taxpayers have been geographically organised. Hence, the politics of tax competition looks beyond the premise of taxing where value is created, and the qualifying criterion of artificiality, previously essential for reinterpreting what accounts for harmful tax competition, becomes partly transcended. This, of course, comes with the rather radical consequence that corporate taxation is made more or less extraterritorial.Footnote ²⁵⁴ Since profits may be taxed without any actual connection to the government taxing them, the exercise of public authority is not preconditioned on any connecting factor having traditionally justified exercise of the power to tax in international (tax) law. This suggests that the politics of tax competition is being driven to a point where even some foundational premises of public law and the exercise of public authority are becoming reformed.

The second and third approaches to income tax competition involve ideas and legal components that differ essentially from the 1990s regulation of tax competition. Rather than merely prohibiting discriminatory tax system properties by way of negative prohibitions, both approaches put forward substantive standards on how to tax. They also differ from traditional market-making rules that enhance cross-border economic mobility through prohibiting imposition of taxes. Rather than constraining the use of public authority, they ensure that the power is indeed exercised. The new ideas point to legal arrangements going beyond the liberal and negative constitutional logic of reining in public authority or safeguarding equality of treatment, and they balance power-constraining properties with power-constituting arrangements. This involves the centralised construction of the capacity to tax income. It also points to transnational legal orders as the means of protecting national public finances and core public powers from the erosion prompted by competitive fiscal federalism. The post-financial crisis period has thus come with novel elements of and ideas for governing tax competition, whose regulation is now clearly less qualified than it was in the 1990s. In terms of contrasting post-war political philosophies, the recent development entails at least a partial rebalancing between the evolutionist and interventionist philosophies of tax competition. Indeed, there has been an increasing push to find acceptable boundaries to the spontaneous integration of income tax systems. Scholars working on the political economy of taxation may fall prey to a melancholic narrative of no counteractions ever taking place in the field of international tax, which is indeed a historically well-warranted assumption, but this narrative should not blind scholars from seeing changes.Footnote ²⁵⁵

In spite of a number of transparency rules and adoption of two other directives, the Anti-tax Avoidance DirectiveFootnote ²⁵⁶ and the Minimum Corporate Tax Directive,Footnote ²⁵⁷ a gap looms between ideational change and legal outcomes. While policy ideas on tax competition have become different, EU law has been relatively resistant to reform; ideational change has not fully translated into legal change. This can be observed, on the one hand, in a number of directive proposals finding no endorsement by the Council. On the other hand, the adopted directives have been outstandingly qualified in their scope of application. In the post-financial crisis era, turning tax policy ideas into law has remained hampered by the rule of unanimous decision-making. Income tax integration is a notorious policy area in which promoting ‘the common good is constrained by the extremely high consensus requirements of EU legislation.’Footnote ²⁵⁸ Given the recent ideational change, the mismatch between ideas and law is perhaps more pronounced than before. Under embedded liberalism, the unanimity rule could ensure that integration would not run against salient national preferences, no more by sacrificing the viability of national tax systems on the altar of market integration than by introducing tax obligations alien to national political choice. As integration consolidated economic mobility as a condition for policy competition, the democracy-enabling rule began to turn into a constraint on democracy. In the contemporary EU, the unanimity requirement plays a key role; while European law is seen as allowing income tax integration for several purposes, the unanimity rule makes adoption of competition-constraining norms extremely hard. The unanimity rule thus comes with the neoliberal effect of paralysing the political.Footnote ²⁵⁹ Under the consensus requirement, those who advocate embedding tax competition into a more elaborated regulatory framework may find themselves ‘waiting for Polanyi’ in what time and again proves to be a more ‘Hayekian setting’.Footnote ²⁶⁰

In the course of integration, the conceivable ways of governing tax competition have typically been identified with European legal norms regulating how Member States exercise their power to tax.Footnote ²⁶¹ This has matched the EU’s predominant character as a community in which law has been ‘the central instrument…for realising integration.’Footnote ²⁶² Rather than assuming core administrative powers or taxing and spending capacities, the EU has predominantly been a ‘legislation-centred’ polity.Footnote ²⁶³ The regulatory mode of operation has also characterised the tax measures recounted in this subsection. Yet, in response to the Eurozone crisis, the demand for European fiscal capacity was repeatedly raised,Footnote ²⁶⁴ and it quickly turned into a debate on the EU’s own taxes.Footnote ²⁶⁵ In the context of Covid-19, the demand for European taxes was invigorated and the Commission pledged to consider EU taxes that would function as the EU’s own resources.Footnote ²⁶⁶ While these are chiefly advocated for functional reasons of enabling the EU to act, this Article has submitted aboveFootnote ²⁶⁷ that the interventionist philosophy of tax competition sees the EU’s own capacity to raise taxes as one additional way of curbing tax competition. As scholars have suggested,Footnote ²⁶⁸ imposing EU taxes on mobile tax bases benefiting most from the European market would balance the fiscal and distributive losses caused by tax competition. The financial transaction tax, a European share of corporate tax and levies on digital business activity, all having featured in more recent debates, could come close to this. For the time being, the EU’s own income taxes are lacking, with the exception of the EU being allowed to tax its officials’ salaries. Furthermore, if mooted EU taxes are to play a significant corrective function in governing tax competition in the future, they should be significant enough. At the same time, Member States must retain their national tax revenues, which means that European taxes alone can hardly enervate tax competition. Rather than the EU’s own taxing capacity, regulating how Member States themselves collect taxes will therefore probably be the chief means by which to address tax competition. Lastly, if revenues from European taxes are spent on European public goods or distributed to Member States under terms of conditionality, such as commitment to structural reforms and competitiveness, European taxes could turn out as counterproductive to the very idea of ensuring sufficient democratic discretion in income tax policy. In any case, introducing European taxes as the EU’s own resources must happen by unanimity.Footnote ²⁶⁹ Hence, adopting them will prove perhaps no easier than regulating how Member States levy their national taxes.