Friday, March 03, 2006

EU: Tax harmonization or tax base harmonization?

The front page of today’s FT (3/03/06), reports that the tax commissioner of the EU is to press ahead with the plans of tax base harmonization in Europe. Additionally, there are plans of introducing a tax to fund the EU budget.

As for the first case, the discussion about harmonizing the corporate tax base and tax rates has a fairly long history, possibly almost as long as the EU itself. Once in a while, though frequently and loudly since the preparations for the most recent phase of enlargement, officials in one of the states considered to have a high tax burden (like Germany or France) raise the issue, which is usually met with fierce opposition of Ireland, and many of the CEECs. Why is this such a hot topic?

First of all, Ireland and many CEECs, especially the Baltic States and Slovakia with their lower tax rates are causing officials from many other EU countries to claim they unfairly compete through taxes, while not bearing the full cost of providing business infrastructure. Arguably, this is one of the reasons why these countries have recently been so successful in attracting businesses, and it is also claimed that they “destroy” jobs in the high tax countries. Thus the “low tax” countries are threatened with EU infrastructure subsidies cuts as a measure of retaliation.
But as the commissioner justly mentions, the current corporate tax rates are not really comparable, as they do not reflect the actual tax burden. One cannot say much about the meaning of an X % rate in one country, Y% rate in another, if the tax bases are different.
Thus in fact, tax base harmonization should be in the interest of the countries that have lower taxes, or that want to compete on tax rates, as the information costs of the actual taxation regime would be reduced. The gain in transparency would allow the corporate sector to see clearly where it can pay less tax. It would also be easier to weigh this advantage against all other advantages like closeness to market, language, infrastructure, business environment etc. Yet it is the “low tax” countries that seem to oppose any talk of harmonization most fiercely, while it is mostly the countries that have allegedly higher taxes that seem to push hardest.

The main reason is that it is not just tax base harmonization at play, but there is also the issue of tax rate harmonization lurking around. While the first, through transparency and thus efficiency should be beneficial for everybody, the second seems a scarecrow for the “low tax” countries. And what they fear most is that relaxing their stance on the discussion of any harmonization in the tax regimes will end in a harmonization of tax rates. This, they argue will be the scrapping of the comparative advantage they have, which is not only lower labor costs, but also lower taxes, which compensate for poorer infrastructure and other inferior business conditions. Moreover they reflect lower burdens on the state budget, thus allowing the countries to compete on taxes.

While the sheer issue of increasing transparency by tax base harmonization seems the right way to go, I find the fears of the countries opposing it somewhat justified. Imposing common, or similar tax rates in the EU would cause more harm then benefits. Moreover, I would not fear, as some of the officials, a race to the bottom as a result in tax rate competition as we can expect that as the countries with lower tax rates grow, their infrastructure improves and thus the subsidies they receive should phase out. The sheer fact of some tax competition may prompt spending reforms in the countries with higher taxes.
Finally, as the world becomes smaller and smaller in business terms, profits tend to be de-linked from the home countries of the companies HQ forcing countries to “harmonize-up” may simply result with the shifts of profits outside the EU.



As for the second point raised, there is the issue of funding the EU budget with a special tax. This seems a simple but appealing idea. I support the view that this could shift the energy to the discussion on how the money is spent and not how big the contributions ought to be, though I think this may be politically even harder to push through than tax base harmonization. Yet, it could yield an additional benefit – a tax intended to fund the EU, whether corporate, or even better some VAT or PIT would cause the nationals in the EU to “feel” the cost of the EU - perhaps it would encourage them to express more interest on how the money is spent, and possibly increase participation in the EU, for instance in parliamentary elections.
However it should not be an additional tax – the burden on most EU activities is already high enough, and therefore it should be designed to substitute for part of the national tax.

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