The myth of tax harmonisation

The myth of tax harmonisation

Bulletin article
Kitty Ussher
01 February 1999

There are no plans to harmonise European Union rates of VAT, income tax or company tax. Yet the inhabitants of Britain could be forgiven for thinking precisely the opposite. At the end of last year a large section of the British press claimed that Oskar Lafontaine, Germany's ebullient finance minister, was plotting to make the British pay more tax. Mr Lafontaine loves to provoke, but there was little substance to support the fantasies of many Eurosceptic commentators.

Tax issues, of course, are discussed at a European level. The Commission has come up with a three-pronged package that finance ministers are supposed to sort out before the Helsinki summit in December 1999. But the point of this package is to smooth discrepancies in the workings of the single market, rather than impose single rates of tax.

The first part involves tackling unfair competition in company taxation. For instance the preferential tax treatment that Ireland has applied to certain types of company and geographical area, in effect disguised state aid, would count as unfair tax competition. A working group chaired by a British minister, Dawn Primarolo, is examining more than 80 such cases. The plan is to deal with examples of unfair competition through discussion and peer-group pressure rather than EU directives.

The second part aims to abolish tax on cross-border payments of interest and royalties between associated companies, thereby saving them much paper work. The third and most contentious part is a proposed directive on the taxation of savings which seeks to prevent cross-border tax evasion by individuals. The Commission wants member-states to agree either to impose a 20% witholding tax on income earned by non-resident individuals, or to pass full details of their earnings to their home tax authority. Britain will not sign up to this directive unless income from Eurobonds is exempt. Otherwise, ministers fear, the City of London could lose business both from the cost of compliance with the directive, and from investors shifting business out of the EU to avoid the tax.

One other proposal, to tax the industrial use of energy, including aviation fuel, has strong support from Germany's Greens. Britain is reserving judgment, unconvinced of the rationale for the EU as opposed to national governments setting energy taxes. Since Spain, Greece and Ireland are strongly opposed, the directive faces little chance of becoming law. The only other tax matter under discussion is duty-free allowances: populist instincts tempt governments to renege on their earlier decision to scrap the allowances, while the logic of the single market pushes them to reaffirm the abolition of duty-free.

In 1992 the then British Chancellor, Norman Lamont, agreed to an EU-wide minimum rate of VAT of 15%. Contrary to what some British tabloids have written, there are no plans to phase out the VAT exemptions that Britain won for items such as children's clothing and newspapers, nor those that other countries obtained for their own special priorities. The Commission would like to introduce an upper limit for VAT rates but there is virtually no support for that among governments.

VAT rates have converged to some extent across the EU in the last decade. But further convergence would cause serious political problems in several member-states. For example if Denmark was forced to reduce its VAT rate from 25% to nearer the EU average it would either have to raise its low payroll taxes or slash spending to compensate, both of which are politically unacceptable.

The Commission has no tax proposals in the pipeline, other than those mentioned in this article. Nor will the arrival of the euro increase the pressure on the EU to harmonise tax rates. After all, the United States has a single currency but its states set different levels of company, income and retail taxes. Those proposals that are on the EU table matter to the interests affected but, if passed, would hardly amount to Brussels taking over the British tax system. In any case all tax directives require unanimity in the Council of Ministers and can thus be vetoed by Britain B or any other country.

But might not the energetic Mr Lafontaine, who at least some of the time appears keen on the EU setting minimum levels of company tax, get his way? His boss, Chancellor Gerhard Schroeder, has supported some of Mr Lafontaine's pronouncements on tax, though not always with enthusiasm, and the same can be said of France's finance minister, Dominique Strauss-Kahn. Belgium and Austria might support minimum levels of company tax. But that is only four countries out of 15 which might back Mr Lafontaine on tax. The Irish and the Spanish, for example, would quickly veto any attempt to harmonise rates of company tax.

Last autumn, when British ministers talked of vetoing Mr Lafontaine's schemes, he hit back by calling for EU decision-making on tax to switch to qualified majority voting (QMV). However, such a constitutional change would require the consent of every member-state. Since no more than four of them are likely to support the introduction of QMV on tax matters, it will not happen.

Even if most countries did want to harmonise corporate tax rates, that would not be feasible until the EU had harmonised tax bases. Because of multiple tax exemptions and differing accounting standards, definitions of the profit base on which tax is calculated vary greatly from country to country. Harmonisation of bases would take many years of meticulous technical regulation, and is not even on the political agenda. In the long run there may be a case for moving towards that goal B not as a prelude to harmonising rates, but to help business. For if EU tax systems were more transparent and comparable, multinationals would be better able to allocate capital efficiently.

Thus the spectre of European tax harmonisation is largely mythical. But why, then, did the story run for so long in the Eurosceptic press? Mr Lafontaine's comments were certainly a gift to Eurosceptic commentators. Unfortunately they caught the British government off-guard: ministers took time to respond and then threatened the veto. They should have pointed out that a majority of EU governments is opposed to the harmonisation of corporate taxes. If France and Germany pursued that objective they B rather than Britain B would find themselves isolated. The British government needs to get that message across, or the myth will continue to nourish the Eurosceptics.

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