I mentioned the ‘Delaware effect’ in our last class. It is NOT a weird sci-fi movie. It is a a concept developed by US lawyers and academics to describe competition in the USA between the 50 states over their attractiveness to business. The relevant dreaded wikipedia entry is http://en.wikipedia.org/wiki/Race_to_the_bottom…..and it is not especially detailed or useful.
True, the Delaware effect relates to competitive laws on company incorporation and NOT corporate tax rates as such, however, the general principle is whether there should be allowable a degree of regulatory competition and whether companies do in fact shop around between states for a favourable deal, not least in tax.
In fact the EU has had many rows over company law standards-or how lax company incorporation requirements should be, and whether a minimum standard should be established to prevent the erosion of company law standards as firms might shop around to find the EU jurisdiction that was the cheapest and easiest to comply with. Typically the Germans have fretted that their companies might move to other EU states as regards their incorporation, to avoid cumbersome rules that, for example, demand that workers/unions have represenatives on company boards.
In fact the history of the Delaware effect in the USA is more nuanced. In some ways many US firms choose to incorporate in Delaware because that is what everyone else is doing! Delaware was among the first US states to develop a modern company law regime in the 1920s, and so some of their advantage comes from being a ‘first mover’ rather than merely an ‘easy ride’ regime. As a result Delaware has a sizeable cottage industry in company law and her state courts are expert in this area. The competitive advantage today is as much one of specialization as it is simply via lower standards.
See: Joseph A. McCaher and Erik P. M. Vermeulen (2005) “Does the European Company Prevent the‘Delaware Effect’?’, European Law Journal, Voll.11, No.6, pp.785-801. Available at: http://www.accf.nl/uploads/Does%20the%20European%20Company%20Prevent.pdf
Britain courtsey of the City of London might have something similar by way of an advantage through specialization.
Moreover, the evidence to date is rather mixed that there is any ‘Delaware’ effect following the possibility of a EU wide incorporation, which was made law a few years back.
One paper I came across, which baldly claims there is a risk of a Delaware effect, actually cites evidence to the contrary:
“This complex regulation leads to a renewed “Delaware effect” among the EU Member States, as every State would aim to provide the most favorable legislation to induce SEs to establish their registered office in its own territory. In fact, according to the European Commission, of the 431 SEs registered as of 10 September 2009, the vast majority (around 65%) have been registered in the Czech Republic (170 SEs) and Germany (109 SEs). The most important negative impetus in the establishment of an SE is the lack of employee involvement in Member States without an employee participation system. It seems that new SEs prefer to establish their registered offices in States with an employee participation system, such as Germany, with its traditional Mitbestimmung while States with troublesome, unclear or no employee participation systems are avoided.”http://www.cjel.net/online/17_1-siclari/#_ftn2
As I understand all of that there seems to be so far not much of a problem-maybe a few German firms have dodged their employee participation requirements by incorporating over the border in the Czech Republic-but many are staying German.On the other hand Simon Deakin, who has been working on this area as regards EU company law standards and competition for some time, points out that the EU may be moving towards a more open US style system of regulatory competition, having previously tried over the last 40 years to maintain national diversity in coporate governance.
See his 2006 paper, at: “LEGAL DIVERSITY AND REGULATORY COMPETITION: WHICH MODEL FOR EUROPE?”, Centre for Business Research, University Of Cambridge, Working Paper No. 323, at http://www.cbr.cam.ac.uk/pdf/WP323.pdf
At best diversity in such laws should be maintained, at worst a bit of regulatory competition seems likely (for now seemingly not excessive either).
Why on earth then should we have identical corporate tax rates or, should we be even much surprised if states within the EU compete over such tax rates?
Why pick on Ireland when Estonia has a policy of ZERO corporation tax if the profits are reinvested in the firm?
The most one can logically argue for might be a minimum floor or threshold rate, but once again one would need clear evidence of a major problem. Perhaps it would have been strategic for Ireland to agree a few years back to a minimum EU level of company tax..say no less than 15%? A handful of MEPs have demanded a minimum rate of 25% in November 2010 (http://www.rte.ie/news/2010/1130/tax-business.html)
The whole debate on unfair competition in the EU lacks an awareness of the reality of regulatory competition within states like Germany and USA, and that although bizarrely the EU is not a federal state like those, we actually have tougher rules preventing local (national) states from undercutting each other.
Finally there is an absence of hard data. How much revenue have the French and Germans lost from French and German companies filing and paying their tax in Ireland? And how many German companies really pay the headline rate of 38% tax on company profits, after their accountants have perhaps factored in tax deductible expenses and payments, etc? My guess is that clever accountants mean few French or German firms really pay the seemingly much higher rates of coporate tax that are advertised.
Like the ‘Delaware effect’ there is more to this story than there at first appears.
Maybe somebody should tell Sarkozy.