The case for international tax co-ordination reconsidered

In a world of high capital mobility, governments may be tempted to undercut each other's capital income taxes to attract capital from abroad Since suc h tax competition mag have detrimental effects for all countries, European policy makers have debated the introduction of a minimum capital income tax rate within the EU. This paper develops an applied general equilibrium mod el to estimate the effects of such tax co-ordination on resource allocation , income distribution and social welfare. The model allows for the concern of policy makers that a nse in capital taxes within the EU may cause a capi tal flight out of Europe. Capital flight will indeed reduce the welfare gai n from tax co-ordination within Western Europe, but a positive net gain wil l remain, although it is likely to be well below 1% of GDP. The gain from c o-ordination will be unevenly distributed across European countries, due to differences in economic structures and in the social preference for redist ribution. Moreover, even of the median voter's gain from tax co-ordination may be small, the gains for the poorer sections of society may be quite lar ge.