Europe will not restore its industrial competitiveness through additional funds, strategies, or policy frameworks. It will do so when firms – especially SMEs – are able to earn, retain, and reinvest a larger share of their income.
In Germany, this constraint is particularly evident. As the backbone of the economy, firms operate in a tax and regulatory environment that weakens internal financing, raises the cost of capital, and constrains their ability to scale.
This is not a new insight. Research by the Organisation for Economic Co-operation and Development consistently shows that corporate taxes are among the most detrimental to growth, especially relative to consumption taxes such as VAT. Yet policy has largely moved in the opposite direction, with the effective burden on business remaining elevated.
This raises a more fundamental question: what is corporate taxation meant to achieve? If the objective is revenue, the system is inefficient. If it is fairness, outcomes remain uneven and often opaque.
Corporate income taxation nonetheless remains central to Europe’s economic policy framework – shaping investment decisions, absorbing political capital, and constraining competitiveness, without clearly delivering on its stated objectives. A well-functioning tax system should be simple, predictable, and supportive of growth. In its current form, corporate taxation falls short on all three counts.
Across Europe, it has become a structural constraint on investment. It weakens internal financing, raises the cost of capital, and slows firm growth. At the same time, it influences investment decisions along multiple margins – how much firms invest, how they finance that investment, and over what time horizon. The resulting system varies significantly across firms and sectors, introducing complexity and distorting the allocation of capital. Large firms can often manage this environment, frequently across jurisdictions. Smaller firms cannot. For them, the burden is not only fiscal, but administrative and strategic.
This is not a marginal issue. It sits at the centre of Europe’s competitiveness challenge – and, equally, at the centre of the opportunity for reform, beginning in Germany.
Germany Shows the Problem – But It is European in Scale
Germany illustrates the challenge in its most advanced form. It combines high effective corporate tax burdens with a system that has become increasingly complex and difficult to use in practice. According to the International Tax Competitiveness Index, Germany has the fourth highest corporate income tax rate among OECD countries. Companies are limited in the extent to which they can use net operating losses to offset income across tax periods, with additional constraints at the level of local business taxation.
At the same time, the broader economic context has deteriorated. Economic growth has slowed, costs have risen, and investment expectations have weakened. Recent survey evidence shows that 52 per cent of international firms now rate the economic situation of their German operations as poor or very poor—nearly three times the level observed just two years earlier—while 23 per cent plan to reduce investment. Within this environment, taxation has become an additional constraint rather than a stabilising factor. For SMEs, the consequences are immediate. They operate with tighter margins, more limited access to finance, and far less capacity to deal with regulatory and tax complexity.
Even well-intended incentives often fail to reach them. Firms may incur significant planning costs simply to determine whether a tax provision applies or is worth using. In Germany, for instance, SMEs can face planning costs of several thousand euros merely to assess the benefits of complex provisions such as profit retention schemes or investment deductions. The result is predictable: measures designed to support investment end up deterring it.
This is not a system that supports investment. It is one that filters it out.
And Germany is not an exception. Similar dynamics can be observed across Europe: high effective corporate tax burdens, legally fragmented regimes, and increasing administrative overload.
A Tax System No One Fully Understands – But Everyone Pays For
Corporate taxation in Europe has reached a level of complexity where even its effects are difficult to measure with precision. Across the EU, corporate tax rates vary widely. The average statutory corporate income tax rate stands at around 21.6 per cent. At the upper end, Malta levies a rate of 35 per cent, followed by Germany (30.06 per cent), Portugal (29.5 per cent) and Italy (27.8 per cent). At the lower end, Hungary (9 per cent), Bulgaria (10 per cent), Cyprus (12.5 per cent) and Ireland (12.5 per cent) pursue more competitive regimes. Such disparities complicate the landscape, encouraging tax competition, undermining harmonisation efforts and creating inefficiencies in the allocation of capital across the bloc.
Beyond headline rates, the variation in how corporate tax bases are defined is even more consequential – and far less visible. Member States differ widely in rules on depreciation, loss carry-forwards, interest deductibility, and the treatment of intangible assets. This means that two firms with identical profits on paper may face very different effective tax burdens depending on where they operate.
Effective tax burdens vary depending on legal form, financing structure, and profit allocation.
At the same time, the burden of taxation does not remain where policymakers expect it. It is passed on – through lower wages, higher prices, and reduced returns. SMEs, consumers, and workers absorb a significant share of it, even when the tax is formally targeted at large firms.
Recent policy developments at EU level reinforce this concern. A draft report of the European Parliament’s Committee on Economic and Monetary Affairs acknowledges that the current layering of EU rules, national systems, and OECD frameworks is undermining competitiveness and increasing compliance costs, while calling for simplification. It also warns that the coexistence of regimes such as Pillar Two, domestic minimum taxes, and legacy EU instruments risks further fragmentation rather than harmonisation, leading to divergent effective tax rates and a structural disadvantage for EU-headquartered firms.
The Distraction: Digital Taxes and Symbolic Tax Fairness
The debate on effective corporate taxation increasingly overlaps with the rise of digital services taxes (DSTs). Unlike CIT, which is levied on profits, DSTs are typically applied to revenues, irrespective of underlying profitability. This places them closer to turnover taxes, creating a fundamentally different set of distortions. Because they are levied on gross revenues, even low statutory rates can translate into high effective tax burdens, particularly in sectors with high operating costs or narrow margins.
“Digital Taxes” were introduced to address perceived fairness gaps in the taxation of multinational firms, particularly in the digital economy. But their economic contribution is negligible – and their costs for users of digital services are not.
Across Europe, digital tax revenues account for well below 1 per cent of total tax revenues, even in countries that have actively implemented them. At the same time, they introduce significant distortions. Because they are levied on turnover rather than profit, they disproportionately affect firms with lower margins and are almost always passed on to consumers and smaller businesses through higher prices and fees.
Yet governments persist with these taxes and effectively rely on large – often non-European – platforms to collect them from European users. For policies framed around fairness and sovereignty, this is a rather odd outcome. Recent policy developments suggest that this approach continues to gain traction. In early 2026, Poland launched public consultations on a proposed DST of 3 per cent, while in Belgium, the Chamber of Representatives has taken forward legislation (if adopted) introducing a 3 per cent levy on digital services provided by multinational firms, with entry into force envisaged for 2027.
In practice, these taxes do not solve the underlying challenges of corporate taxation. They add another layer to an already complex system – one that is harder to administer, less transparent, and more prone to double taxation. The political visibility of these measures stands in stark contrast to their fiscal relevance. They are, in many respects, tax policy by symbolism.
The Missed Opportunity: VAT as Europe’s Real Fiscal Anchor
While policymakers debate how to extract more revenue from corporate income and digital activities, a far more significant issue remains largely underexplored. Across Europe, value-added tax (VAT) consistently generates several times more revenue than corporate taxation. In countries such as France, VAT revenues exceed corporate tax receipts by a factor of three, while digital taxes contribute only marginally.
This imbalance is also reflected at the EU level. VAT-based contributions form a key component of the Union’s “own resources,” accounting for around 9.5 per cent of total EU revenue in 2024. Even more striking is the untapped potential within existing VAT systems. Policy gaps and exemptions amount to hundreds of billions of euros in lost revenue across major European economies. Europe is adding increasingly complex corporate and digital taxes to raise relatively small revenues, while leaving larger, more stable, and less distortive tax bases underutilised.
A More Rational Starting Point: Make Existing Taxes Work
In Europe, CIT plays a surprisingly small role in public finances, yet it has a disproportionate impact on economic outcomes. OECD data confirm that it accounts for roughly 5–6 per cent of total tax revenues in Germany and France. It is therefore striking that such a limited revenue source dominates ideological debate – even as it quietly weakens Europe’s industrial competitiveness. It affects where firms invest, how they structure their operations, and whether they scale within Europe or elsewhere. At the same time, its complexity undermines both efficiency and perceived fairness. This reinforces the earlier point: the problem is no longer design, but purpose.
From Taxation to Investment Capacity
Europe’s widely cited multi-hundred-billion investment gap – highlighted in numerous analyses, including the Draghi Report – is often portrayed as a financing shortfall. In reality, it points to a deeper issue: insufficient profitability at the core of Europe’s industrial competitiveness. Firms invest when they can generate sufficient returns. Corporate taxation plays a direct role in determining those returns.
Every euro taxed at the corporate level reduces the resources available for reinvestment within the firm. Over time, this weakens the internal financing capacity that underpins sustained growth – especially for SMEs and firms aiming to expand across borders in the EU, as outlined in the EU’s Annual Report on Taxation. A more effective approach would recognise retained earnings as a strategic resource rather than a residual to be taxed.
Germany Can Lead – and Europe Can Follow
Germany is particularly well placed to initiate such a shift. As Europe’s largest economy and a central node in European value chains, its tax policy choices have systemic effects on investment patterns, supply chains, and policy debates across the Union. Domestic pressure from industry for a more competitive tax environment is increasing, while current discussions at the European level – including calls for simplification and a renewed focus on competitiveness – provide a supportive policy context.
This debate should move beyond incremental adjustments. The relevant question is no longer how to refine corporate taxation, but whether it remains an effective instrument in its current form. Retained earnings are the principal source of corporate investment and productivity growth. Yet current systems tax these returns while generating relatively modest revenues. In Germany, corporate tax receipts amount to roughly one-third of VAT revenues – a pattern broadly observed across European economies.
This is not a problem that can be resolved through stronger enforcement. It reflects a structural feature of modern tax systems: corporate taxation contributes comparatively little to total revenues while exerting a measurable impact on firms’ liquidity and investment decisions.
A more fundamental rebalancing is therefore required. In Germany, replacing corporate tax revenues through VAT would imply a standard rate of around 23 per cent – well within the range already observed in several EU Member States, including Hungary at 27 per cent, and Finland, Denmark and Sweden at around 25 per cent. While politically demanding, this illustrates that the constraint is not practical feasibility but policy choice. Germany’s role is therefore pivotal. A credible strategy centred on tax simplification and a gradual shift away from taxing corporate income would substantially strengthen domestic competitiveness while providing a clear benchmark for reform across Europe.
At its core, this is less a question of technical design than of economic direction. By rebalancing the tax system towards supporting investment and retained earnings, Europe has an opportunity to enhance productivity, unlock growth, and reinforce its industrial base in a more durable and sustainable way.
The question, therefore, is not whether Europe can afford such a shift. It is whether it can afford not to.