The EU’s new era of “fair company taxation”: the impact of DEBRA and Pillar Two on the EU Member States’ effective tax rates

Abstract The European Union (EU) recently implemented the Minimum Tax Directive (Pillar Two) to ensure that profits of large companies are at least taxed at 15%. At the same time, the European Commission proposed the Debt-Equity Bias Reduction Allowance Directive (DEBRA) to reduce the tax-induced distortions between debt and equity financing. In this simulation study, we examine the impact of DEBRA, Pillar Two, and their interaction on countries’ effective tax levels. Based on our results, we evaluate the policy reforms’ effectiveness in achieving their objectives. Our analysis of DEBRA shows that, on average, the effective tax levels decrease and the debt-equity bias diminishes, which should lead to more equity financing. In low-tax countries, Pillar Two increases the effective tax levels, but not necessarily up to 15%. Still, as the deviations from the 15% minimum effective tax level remain rather small, Pillar Two mostly succeeds in setting a floor on international tax competition. The interaction of both directives results in a convergence of tax levels across the EU, creating a more level playing field. However, Pillar Two offsets the tax-reducing effect of DEBRA and limits its ability to reduce the debt-equity bias.