TCS Daily

Tax Terrorism

By Ruta Vainiene - October 15, 2004 12:00 AM

The Longman Dictionary of Contemporary English defines the word "terrorize" as "to deliberately frighten people by threatening to harm them, especially so they will do what you want". It's not just political terrorism we are facing today. A French initiative to harmonize direct taxes can be viewed as a clear manifestation of economic terrorism.

Recently the French finance minister has "deliberately frightened" EU countries with low taxes by "threatening to harm" them. How? By restricting their use of EU structural funds if they don't raise corporate tax rates.

EU tax laws cannot be changed unless all member states agree. This unanimity requirement has been the only safeguard to slow the movement of tax harmonization. But, as we all know, attempts to abolish the right of veto have been quite active lately and will certainly be put forward again. When? I am afraid; as soon as it appears that the terrorizing deeds don't bring the waited results. And if the right of veto is abolished, Europe will witness genuine economic terrorism where violence of the strong and the big against the small and the weak is the moving engine.

The situation is disturbing, since everybody knows that terrorism provokes a "lose-lose" situation. It benefits neither the attacking nor the attacked side. The only gain that companies would derive from it is equal rules that are easier to follow.

But to raise taxes for the sake of simplicity is far from a brilliant idea. Companies would certainly agree to spend time learning different rules if this enabled them to pay less in taxes. Actually, they are used to doing so and they will continue searching for low-tax places to do business. If they don't find such places in Europe, they will seek for them elsewhere around the globe.

Let's have a look at what lies behind the intentions to increase tax rates in the new member states. Why do high tax countries have a relentless itch to put an end to the so-called "harmful" tax competition, or to be more precise - to end tax competition as such? The most conceivable explanation is that countries with high taxes are simply frightened at any form of competition as they are almost sure they will lose the battle.

Taxes directly affect production costs. High taxes increase these costs. As a result, it becomes more expensive to produce, and more difficult to sell, goods and services. Add lower labor costs and cheaper energy resources in the new member states and you will be facing a rather strong competitor.

Fears of losing investments along with all the resulting effects are the main reason why high tax countries are so conspicuously afraid of countries new to Europe which are economically still weak today - weak, but with huge potential for growth.

Rapid economic growth is vital for the new member states. For example, the average personal income in Lithuania is \ just 40 percent of the EU average. People are not well off, and the only way to reach the EU level is to grow faster. Low taxes lay the foundations for economic growth.

If taxes are raised, growth will undoubtedly be arrested, and the new member states will remain the poor outskirts of the rich Europe for much longer than under the current tax rates. The question is whether the "old European" countries are interested in having poor sisters and brothers. Or are they simply short-sighted in their goals?

To have a feeble companion is much worse than to have a wealthy one, and I bet that successful businessmen would certify that. If Europe is eager to be a "success story," competition should be allowed to work inside the Union. Europe must be concerned about having each member competitive and strong, even more so if this may be achieved without sacrificing the wealth of others.

Competition is not about living at the expense of one's neighbor. It is about searching for own ways to survive. It is not about cutting and dividing a fixed pie. It is about creating a bigger pie.

The wealth of the "old Europe" - if maintained and supported by the means of economic terrorism - will not be sustainable at all. Economic terrorism is about refusing wealth.

If harmonization takes place, in a year or two all countries will face even bigger difficulties in creating a competitive Europe. Why? Because the core of the problem would not be solved, not even touched. The problem would be only postponed and aggravated. Eventually, a tax cartel will be created.

A state cartel is much more harmful than the allegedly harmful tax competition itself. It limits an individual's right to choose and damages private finances. I doubt if there's someone courageous enough to say that private finances are not important and that they should fall victim to state finances.

The remedy for Europe is not a tax harmonization or economic terrorism, but the implementation of serious economic reforms that would unleash economic initiative. It is a test of Europe's readiness to pursue urgent change, and at the same time a chance to do so. It is a unique opportunity to follow the well-tried recipe for growth which is being proposed by the low tax countries, and this opportunity should not be wasted.

The author is Associate Policy Analyst of the Lithuanian Free Market Institute.


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