A harmonised tax area within the EU?

Prepared by Jens Tapking

Published as part of the Financial Integration and Structure in the Euro Area 2026

Harmonising (corporate) tax rules across the EU is challenging as it requires unanimity in the Council of the European Union, and the short-term costs of harmonising tax regimes are likely to be high for individual Member States. To quote the European Commission: “Adopting harmonised legislation on taxation requires the unanimous agreement of all Member States in the Council, which has tended to act as a brake on the adoption of common rules”.^[1] For EU legal acts on direct taxation, Article 115 of the Treaty on the Functioning of the European Union (TFEU)^[2] requires unanimity in the Council. At the same time, harmonising tax rules may prove costly for Member States for at least two reasons. First, individual countries’ tax laws are typically complex. This might make it difficult to rework them with a view to harmonisation. Second, Member States use not only tax rates but also other tax rules, such as provisions on the depreciation of capital assets, to achieve specific policy goals. If tax rules are harmonised, it may no longer be easy for Member States to change them in the way they want.

Instead of aiming at harmonisation across all Member States, it could be more fruitful to give each country the option of adopting a set of uniform tax rules, thereby creating a harmonised tax area within the EU, while full harmonisation across all Member States could be achieved at a later stage. This concept is similar to the introduction of the euro in 1999 in initially 11 out of 15 Member States at that time. Some Member States may face relatively low costs in harmonising tax rules. These countries could decide to establish an area of harmonised (corporate) tax rules based, for example, on a proposal by the European Commission. This area could become especially attractive for corporate investment, which could, in turn, encourage other Member States to join at a later stage. The tax rules within this area could take into account national modalities to the extent feasible.

This idea can be illustrated by a stylised example involving firms that wish to diversify investments across different countries but do not want to be exposed to multiple tax systems. Let us suppose that there are only four EU countries: A, B, C and D. There are N firms in each country, each of which is willing to invest the same amount, say one euro for simplicity. The firms believe they would benefit from diversifying across all four countries, meaning they would in principle like to invest 25 cent in each country. But they do not want, or are not able, to be exposed to more than two different tax regimes. As a result, as long as all four countries have different tax systems, each firm will invest in only two countries: 50 cent in its home country and 50 cent in one other country. We assume that the same number of firms from any given country invests in each of the other three countries. The resulting investment flows are shown in the first part of Table 1 below. For example, Country A receives investment of 1/2*N from firms in Country A and of 1/6*N from firms in Country B. Now suppose that two of the countries, say A and B, decide to bilaterally harmonise their tax rules, as these two countries have relatively low harmonisation costs, while the other two face much higher costs. Each firm would now invest in three countries – its home country and Countries A and B – thus achieving a higher level of integration. The second part of Table 1 shows the new investment flows. Countries A and B now attract more investment than before and C and D less investment. Countries C and D could now be interested in joining the harmonised tax regime of countries A and B, as this would allow them to attract lost investment (third part of Table 1). This would result in full integration of corporate investments across the four countries.

While reality is much more complex than the stylised example may suggest, it does illustrate positive effects of, and a possible path towards, harmonised tax rules. More discussion and analysis is needed before firm conclusions can be drawn, but some tentative conclusions may already be possible at this stage. Many firms would likely diversify their investments more readily across the EU if tax rules were more uniform. This could help countries within a harmonised tax area to attract additional investment. Countries outside this area may receive less investment, which would provide incentives for them to also join the scheme at some later stage. It is smaller countries that could benefit the most from joining the harmonised tax area from the outset. If these Member States continue to have highly country-specific tax rules, many foreign investors may consider the fixed cost of dealing with these rules too high, given the more limited investment opportunities in smaller countries.