**1. Introduction**

Corporate income taxes (CIT) are paid by companies including those operating in several countries. Therefore, there is a strong international aspect in its design, administration, and compliance. In scientific and professional literature, this aspect is covered under the topics of tax competition, tax coordination, and tax harmonization. The scientific interest in international tax competition and related topics is not new. The interest is sustained by a rising capital mobility in the last 40 years and increasing concerns over capital flight and loss of public revenue due to base erosion and profit shifting. The problem stems from the dual objectives of

© 2016 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. © 2018 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

the governments. On the one hand, governments seek to attract investment into the country, or region, or locality, and therefore offer incentives to potential investors often in the form of preferential tax treatment. In doing so, governments engage in harmful or wasteful tax competition. On the other hand, governments need to collect enough tax revenue in order to provide a sufficient level and quality of public services and fulfill other functions demanded by the public. This calls for a rather complicated balancing between those objectives. Loss of revenue may lead to suboptimal provision of public services or require difficult policy decisions on the higher level of government or at the supranational level, including tax coordination and tax harmonization.

this a zero-sum game. When all governments behave this way, none gain and consequently communities are all worse off than they would have been if local managers had made decisions based on marginal costs [2]. More recent interest in the topic was prompted in part by fears that tax competition among the increasingly economically integrated EU nations will over time significantly reduce the level of capital income taxation to the extent of announcing the death of CIT [12]. Thus, governments must solely rely on financing their expenditures from the taxes on immobile factors of production (labor/land) and on consumption taxes,

International Aspects of Corporate Income Taxes and Associated Distortions

http://dx.doi.org/10.5772/intechopen.74213

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"Basic tax competition model" has been built by Zodrow and Mieszkowski [13] and Wilson who formalized the notions on tax competition developed by Oates [2]. Alternatively, the model is known as a ZMW model or a simpler version, according to Wilson [2], is known as ZM model [14]. Similar to Tiebout's model [15], the ZM model is built on those assumptions "(1) A large number of homogenous jurisdictions; (2) Perfectly competitive markets; (3) A Nash equilibrium in which each jurisdiction takes as fixed the after-tax return to capital and the tax rates set by other jurisdictions; (4) Fixed population and land in each jurisdiction; (5) Identical tastes and incomes for all residents of all jurisdictions; (6) A fixed national capital stock that is perfectly mobile across local jurisdictions; (7) A single good that is produced by capital and the fixed factor (labor/land) in each jurisdiction; (8) Government services that are "publicly provided private goods," benefit only residents, have no spillover effects to other jurisdictions, and can be modeled as purchases of the single private good;(9) Two local tax instruments—a "property tax" that applies to capital income and a head tax; (10) Local governments that act to maximize the welfare of their

In the ZM model, interjurisdictional competition results in "race to the bottom," as all taxes on capital income are eliminated. Governments are only able to impose taxes on immobile factors of production only. The insight of this result serves as a model for a "small open

An important assumption of the basic tax competition model is that local public services are essentially another consumption good that enters individual utility functions. However, as Sinn correctly observes, one of the most important roles of government is to redistribute income which has nothing to do with consumption goods [17]. Income redistribution at least partially represents social protection against income uncertainty attributable to different macroeconomic shocks and, more broadly, differences in natural endowments and access to education. Private markets fail to insure against income uncertainty and other risks; therefore, public programs designed to smooth such shocks improve both equity and efficiency of resource allocation. Tax competition results in lower tax rates on mobile factors of production and thus limits the power of governments to engage in redistributive activities. It imposes important social costs. In case of perfect mobility of both capital and highly skilled labor, tax competition implies that only benefit taxes can be levied and the policy of income redistribution is given up. Though Sinn's observation relaxes one of the assumptions of the basic model, it fundamentally reinforces the central message of the

which have their own constraints and disadvantages.

(identical) residents" ([1, 15] p. 654).

economy" [16].

basic model.

Theoretical studies in public economics provide the conditions for the economic effects of tax competition to be either harmful or useful [1–3]. Those conditions are varied and often hard to reconcile in theoretical models. In empirical research, they lead to inconclusive results. Negative economic effects of tax competition include "base erosion" of taxes on mobile factors of production that ultimately leads to the underprovision of public services and frustrates governments' efforts to redistribute income. The useful effects of tax competition are largely supported by the initiators and followers of public choice theory who find in tax competition efficiency-increasing effects. It limits the tendency of local governments to overexpansion and constrains the growth of a Leviathan state [4, 5]. Empirical literature on tax competition leaves us with a similarly diverse picture [1, 3].

This chapter attempts to synthesize growing scholarship on the economic effects of tax competition and includes the review of the latest trends in CIT, foreign direct investment (FDI), and profit shifting. The topic is of high relevance since tax avoidance and evasion through base erosion and profit shifting continue unabated for some time and may be on the rise due to the ever more sophisticated tax-reducing techniques used by multinationals and increasingly mobile individuals [6–10].

The sections that follow will (1) review the theory of tax competition including "basic tax competition model" and its extensions, (2) present recent trends in corporate income tax rates and revenue in the EU and OECD countries, (3) survey empirical literature on tax competition, including evidence of the relationship between tax rates and FDI, and (4) outline what is known about the magnitude of tax avoidance through base erosion and profit shifting. Finally, the last section concludes.
