TCS Daily

When Efficiency Is Bad

By Jeremy Slater - July 9, 2003 12:00 AM

With one hand they giveth and with the other they taketh away -- and so it is with taxes in the European Union.

Recently the German government announced it would lighten the very heavy tax burden on its citizens starting at the beginning of next year. There were hurrahs from those who think that, unlike death, taxes might be avoidable; but these will become groans once folks find out they will simply end up paying taxes in a different form.

The German package aims to cut the government's tax take by some €18 billion. Chancellor Gerhard Schröder will face a struggle to get the rest of his cabinet to agree to these changes as various departments try to defend their budgets. Perhaps his strongest weapon is that he has the support of Finance Minister Hans Eichel.

However, even if the whole government gets on board the effort to revive Germany's sluggish economy through tax and other reforms it faces potentially significant opposition from, of all places, Brussels. Already there have been warnings from the European Commission to Germany about the dangers of overshooting the 3 percent public spending limit enshrined in the EU's stability and growth pact.

"The German government should not count on the support of the Commission if their budget proposals are not compatible with the fiscal rules," said Pedro Solbes, the monetary affairs commissioner. He also suggested that the chances of a German economic revival would be improved if Berlin were to tackle health care and pensions reform rather than give money back to the people.

But here's the real problem for ordinary German taxpayers. Even if they do see some much-needed relief from the high income tax rates they pay, they will soon find the government is stinging them somewhere else.
Case in point: After a decade of negotiations the 15 countries that currently make up the EU have agreed to a withholding tax regime on savings deposited abroad. From now on the interest earned on these deposits will be taxed at 10 percent across the EU -- or information on these accounts will be passed back to the local tax authorities.

Germany was one of the major movers behind this agreement, since every year it loses out on billions of euro deposited abroad by German nationals in accounts in tax-friendly Luxembourg and Switzerland. It got to the point where German police would station themselves at border crossings to search for drivers they suspected of concealing life savings in the trunks of their cars.

But the issue here is not the avoidance but the level of taxation. The current EU thinking is not favorable for those who like that level to be low in the interests of promoting growth. Brussels bureaucrats prefer the seemingly benign-sounding concept of "harmonization" over tax competition. Unfortunately, in most cases this results in tax rates being harmonized upward, to the level of, say France's, rather a down to that of Ireland's or the UK.

The EU's draft constitution would keep tax matters a national rather than a European issue. But this won't prevent would-be tax-hikers from finding backdoor ways to do it at the European level. It's already happening.

Besides the tax on foreign savings there are other targets, such as the charging of value-added-tax (VAT) on e-commerce transactions. At the moment VAT is paid on purchases made within the EU, but a new proposal would levy the tax on all transactions made over the Internet whether or not the company is based in the EU.

So far this has met with great resistance from the Department of Commerce and other representatives of the US administration in Washington. It is also, quite understandably, being opposed by internet providers and e-tailers who already have a tough enough time succeeding in Europe. However, their outcry has not stopped Brussels from pursuing the issue and the debate could become as contentious as the one over GMOs.

In most cases, harmonization improves the efficiency with which things are done in Europe. But with taxes it has the opposite effect. Increased tax levels will make it harder for European businesses to operate effectively and they could choose either to move their operations outside of the EU, as German manufacturers are doing already, or find ways to avoid the tax.

Either way, tax harmonization is bad news for the European economy.

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