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Imperfect Harmony

Must Europe harmonize taxes? Not according to this research by Richard Baldwin and Paul Krugman. Indeed, they argue, harmonization is likely to do more harm than good. James Morgan, talks to Richard Baldwin, one of the authors of "Agglomeration, Integration and Tax Harmonisation", CEPR Discussion paper 2630. Some of the issues they discussed:

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Questions and Answers

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1. Do you have any sympathy at all with what one might call the traditional view of what tax competition means to the location of industry? [James Morgan]
... this doesn’t capture what actually has been going on in both European tax competition and European Integration ... [Richard Baldwin]

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2. And that’s why you say in fact there has been no race to the bottom, and that countries have not been competing on fiscal policy [James Morgan]
... If this traditional view is right we should have seen tax rates (especially on mobile factors) coming down, but this isn’t what happened  ... [Richard Baldwin]

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3. Corporations haven’t minded at all? [James Morgan]
... in many ways the advantage of the locating in Germany is exploited by the government by having higher taxes, but industry still likes to stay in Germany ... [Richard Baldwin]

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4. That attractiveness, is that because high taxes produce high levels of public services, which employers like? [James Morgan]
... The primary attractiveness of location is agglomeration. Governments will adjust taxes so that firms continue to stay in the cluster ... [Richard Baldwin]

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5. Is that always going to be true? We have heard about the new paradigm and new industries that don’t need to be near customers or suppliers at all, they can just buy and sell over the internet [James Morgan]
... for a long time agglomerations will be important. Industry is still concentrated spatially in the US, despite the high degree of integration ... [Richard Baldwin]

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6. You call this a new economic geography view, but it actually sounds like quite an old economic geography view. Industry is there because it’s there [James Morgan]
... the new economic geography predicts that agglomeration forces will be strongest for intermediate trade costs and degrees of integration: very important for understanding what’s been going on in Europe ... [Richard Baldwin]

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7. What are the implications for governments in all this, because if Germany has no reason to change taxes at all, could Spain or Portugal in any way compete with Germany? [James Morgan]
... the advantage of slightly lower taxes in Spain, for example, is not going to attract part of an industry. They either get all or they none. The German government, when it sets tax rates. makes sure that the Spanish get none of it .... [Richard Baldwin]

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8. But one still has a situation where tax rates (corporate or whatever) are still lower in the peripheral countries than they are in the core countries. Why is that? [James Morgan]
... Countries with industries will exploit that, the governments will extract some of the benefit of the clustering ... [Richard Baldwin]

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9. We know that labour costs can play an important role. Volkswagen buys Skoda and transfers production there, doesn’t that run against your agglomerative theory? [James Morgan]
... When the Czech Republic became a country where one could invest, you had some one-time adjustments. Now there is capital investment going on in the Czech Republic; the wages are going up and adjusting ... [Richard Baldwin]

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10. When you were looking at this problem did the theory come first or was it the data that created the theory? [James Morgan]
We went looking in the data for U-shaped curves and we found them. The tax gaps were widening at the first phase of integration and narrowing afterwards, so it was like a good detective story. We looked for the footprints and they were there [Richard Baldwin]
 

DP2630 Agglomeration, Integration and Tax Harmonization - Report Details

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Must Europe harmonize taxes? Not according to new CEPR research by Richard Baldwin and Paul Krugman. Indeed, they argue, harmonization is likely to do more harm than good - Read more in "European Economic Perspectives"
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