TCS Daily

Backdoor Tax

By Jeremy Slater - September 15, 2004 12:00 AM

Tax harmonization reared its ugly head again last weekend as the European Union's finance ministers gathered in a plush Dutch seaside resort to discuss Europe's pressing economic matters. On this occasion many of the matters discussed were routine, but there were intense and heated discussions over the issue of corporate tax rates -- Old Europe's favorite new bugaboo.

Not surprisingly, France (loyally supported by Belgium) is leading the charge for a new scheme. Paris and Brussels argue that low rates of corporate tax in the new European Union member states are a threat to more established and richer economies in the West, and constitute a form of "tax dumping". The French and the Belgians are afraid that companies may leave their current domiciles to set up in countries where taxes are lower, therefore potentially creating industrial wastelands in western Europe. This threat is known as "delocalization" in the corridors of power in Paris. It appears that no-one in a senior position in the French treasury has explained to his political masters that there could be some benefit from this policy, as faster growth in central Europe and the Balkans would benefit the rest of the EU by producing more consumers to buy goods from other European countries.

Those who oppose the threat of tax harmonization say that it would do nothing to improve Europe's economic performance and in fact would undermine any chance of expansion as wealth creation would become more difficult, therefore leading to a fall in growth and a rise in unemployment. They also argue that taxes in the new member states need to be lower to compensate for the poor condition of the transport and communications networks there.

They add that countries should choose their own tax levels, so that they can potentially enjoy the success that Ireland has in the past 15 years. In the 1980s the country had a high level of taxation and unemployment. Its best educated people left for either London or New York and therefore the country's considerable investment in its schools and universities was largely going to waste. This changed in the early 1990s when the Irish government decided to cut rates of corporate tax in certain areas, such as the Dublin docks, to 0 percent and to around 10 percent for the rest of Ireland. This led to massive inward investment from US companies in particular, but from all round the world, which helped rebuild the country's infrastructure, created jobs and helped Ireland to hold on to its best students. The revenue created from taxes increased, thus allowing the government to cut a very high rate of income tax to less than the European average, which gave another boost to the economy as Irish citizens spent the extra cash they had on consumer goods.

Shortly after the Dutch meeting ended the anti-harmonization force mobilized. Among others, the Lithuanian Free Market Institute (LFMI) launched a broadside against France's proposal. The LFMI claimed that "Undermining tax competition would markedly reduce the incentives of EU governments to enhance performance of the public sector and to collect and allocate their budgets more effectively. For this reason, LFMI encourages governments of the EU member states to discard plans to harmonize direct taxes. Instead, governments should take measures to carry out social and economic reforms, which would lead to more favourable conditions to boost people's initiatives and economic growth."

What this response does not express was the anger caused by another tactic proposed by the harmonizers: if the countries of central Europe and the Balkans do not raise their tax rates then the European Commission should cut their development funds. Many saw this as a form of blackmail by the French. The Slovak Finance Minister Ivan Miklos described the suggestion as "absurd". Even Karl-Heinz Grasser of Austria, a country known for its relatively high taxes, said the idea had "no be realized". His negative response to the suggestion was probably motivated by the fact that the Austrian government had decided to cut rates of corporation tax only January of this year.

Europe's finance ministers voted against France's idea, but a majority agreed to a Commission proposal to consider a plan (this is the speed at which the EU works) to harmonize the base on which company taxes are calculated in different countries. From an accountant's or financial director's point of view this could make a lot of sense as it would make operations more transparent and should cut business costs. The Commission has said that a business would then pay the rate of corporation tax of its home country and would pass this on to the treasuries of all the countries it operated in.

However, such a proposal means that the EU could then have a base on which it could create a single level of taxation. Surely this is tax harmonization by the back door and therefore anyone who opposes such a move should keep a very close eye on further developments in this area.


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