Fiscal Interactions Among European Countries: Does the EU Matter?

This paper provides a simple theoretical model of capital tax competition between countries that differ in spatial location, and where cross-border investment costs are proportional to distance (a gravity model). We model EU membership as a reduction in ‘distance’ between countries. Precise predictions about reaction functions’ intercepts and slopes are derived. In particular we find that joining the Union lowers tax reaction function’s intercept and that all countries react more to member countries than they do to non-members. These predictions are largely confirmed using a panel data set of statutory corporate tax rates on Western European countries