The issues

A major part of the economic benefits from the internal market and the economic and monetary union in the European Community (EC) is expected to stem from the integration of EC capital markets. The idea is that capital market liberalization and the ensuing pressure of competition will eliminated monopoly rents and X-inefficiency in the financial services sector, allow more scope for economies of scale in that sector, and channel the supply of capital to those parts of Europe where it can be most productively invested.

From the perspective of a tax economist, this scenario may be too optimistic. The reason is that the present national systems of capital income taxation in Europe are not very well coordinated. Liberalization will cause capital to flow to those countries which offer the highest private rate of return, but these may not be the countries providing the highest social rate of return, given the wide divergences in effective tax rates on income from capital. Moreover, financial services may not come to be provided by least-cost producers, but rather by producers in countries offering the most favourable tax climate for investors and financial institutions.

In this chapter some of the most important tax obstacles to an efficient allocation of capital within the EC will be discussed; consideration will also be given to the way in which these obstacles may be removed.