Europe’s stability pact. A case for nationalism

European governments need more fiscal freedom, not less

POLITICIANS are not noted for consistency. Consider two proposals by the German chancellor, Gerhard Schroder. Last year he chastised central Europeans for their low tax rates, suggesting that countries with below-average corporate taxes might forfeit European Union subsidies. Yet this week, when Mr Schroder demanded that the EU's near-defunct stability and growth pact be relaxed by exempting swathes of public spending from its budget-deficit ceilings, he added in a Financial Times article that “intervention by European institutions in the budgetary sovereignty of national parliaments [should be] permitted only under very limited conditions.”

Most EU countries agreed with Mr Schroder's first suggestion; many have loudly denounced what they call “unfair tax competition”. But almost all EU finance ministers, even those who say they want a more flexible stability pact, were quick to criticise his second, insisting on the need for strong, centrally enforced rules and greater co-ordination. As so often in the EU, these responses are precisely the wrong way round. Mr Schroder was misguided in making his first suggestion, but he is essentially right in his second.

What connects claims of unfair tax competition to rows over the stability pact is the notion that it is right for Brussels to interfere in national governments' decisions on taxes and spending. Yet this is a bad idea, on both political and economic grounds. Fiscal policy lies at the heart of democratic electoral politics, which is conducted at the level of nation-states. If an elected government wishes to cut taxes, boost spending or even run a bigger budget deficit, it is a travesty of democracy if the European Commission stops it.

Some argue that central rules are needed on economic grounds, to underpin the euro or to stop a race to the bottom in taxes. Actually, the opposite is true. Because euro members have shed their power to pursue independent monetary and exchange-rate policies, they need more fiscal independence, not less. As for fears of a race to the bottom in tax rates, there is little sign of this happening. On the contrary, most taxes in the European Union, including those in central Europe, are still too high. It would in any case be pointless to impose higher corporate-tax rates in the EU, for foreign (and domestic) investment can easily shift to lower-tax jurisdictions that are beyond the reach of Brussels.

What, finally, about the worry that inspired the stability pact in the first place: the need to stop profligate euro members running up big deficits at others' expense? Again, one answer is that it is not happening: despite the stability pact's near-demise, European fiscal consolidation has mostly continued. But the bigger point is that financial markets are quite able to exert discipline, even over euro members: witness the credit downgrade suffered by Italy last year. The only rule that is essential is a reaffirmation that neither the European Central Bank nor any other EU body will stand behind a national government's debt - so that if it gets into trouble, the pain will be felt at home, not abroad.

There is, in short, a good reason why most governments have insisted on retaining national vetoes over EU tax plans. Taxes should be fixed nationally, not supranationally. And what Europe needs are lower taxes and more tax competition, not higher taxes and more tax harmonisation. Mr Schroder, and indeed other European leaders, should follow the logic of his newspaper article this week.

Editorial says that European governments need more fiscal freedom, not less.

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