Berlin and Paris harden stance on tax

By Dana Spinant

Date: 27/05/04

THE EU's enlargement on 1 May has been overshadowed by prosaic disputes over taxes, as the German Chancellor Gerhard Schröder launched a bitter attack on "fiscal dumping" by some of the ten new members.

With the accession to the EU of several low-tax countries, France and Germany are seeking to revive a controversial plan to harmonize corporate taxes to avoid dumping.

"If new member states maintain low tax levels and get infrastructure financed by the EU, we will have to have a discussion," Schröder said.

The chancellor's officials have since qualified the terms of the "discussion" by calling EU subsidies for newcomers into question if they refuse to raise business tax levels.

"This is not acceptable," one senior German official told this newspaper. "The new members use money from the EU to finance their low taxes, while countries such as Germany will have to pay more for them and therefore increase their own taxes to be able to pay more to the EU's coffers. It is an unfair vicious circle."

Tax attack?

Eager to attract foreign investment, most new members have lowered corporate tax levels. While their taxes on business profit are frequently bellow 20%, the EU-15's average is currently 33%.

Old member states (France and Germany are the most vocal) fear the newcomers will use the payouts from the Union to lower corporate taxes and attract investment to the detriment of the high-tax EU paymasters.

Before 1 May, Ireland had been constantly rebuked for such a practice, as it applies a 12.5% corporate tax. "We could live with one Ireland, but we cannot live with ten," one French official in Brussels said. "The system is not sustainable."

But poorer new member states, which face a considerable catch-up challenge, are adamant they are entitled to apply the Irish model - Ireland has spectacularly succeeded in bridging the wealth gap.

Harmonious or harmful?

The supporters of tax harmonization argue that unchecked competition would lead to a "race to the bottom" in which tax rates would dip so low as to threaten the member states' abilities to supply public services, such as education or health care.

Hence the demand for a harmonized tax rate at a level that ensures the adequate supply of such services.

The logic is simple: as "factor mobility" increases within the single market, pressure will grow on member states to slash taxes to attract business.

On the other hand, proponents of competition claim this is vital to supporting growth: after the "Europeanization" of monetary policy following the introduction of the single currency, fiscal policy, including taxation, is one of the last tools remaining to allow governments to influence their economies.

But while fully fledged tax harmonization is not desirable (and at any rate impossible under the present treaty rules), the imposition of a minimum tax floor would be advisable.

Such a scenario would still allow for competition, which is vital to prevent governments from inefficiently spending too much money, but would avoid a race to the bottom.

Unregulated tax competition would reduce governments' revenues, leading to the risk of underprovision of public services. But by being forced to spend less, governments would slash superfluous spending and eliminate waste in the public sector.

But as reductions in taxes may be welfare-decreasing, a minimum tax floor could be in citizens' long-term interest.

Harmonize systems, not rates

The first step towards regulating taxation could be the introduction of a standard scheme for the calculation of corporate tax. Internal Market Commissioner Frits Bolkestein had suggested to EU heads of state and government at their March meeting in Brussels that they bring rules on how companies are taxed in line with each other, to make comparisons easier.

However, he said that would have to be done through "enhanced cooperation" by a number of member states, as not all are likely to back the plan (the UK and Ireland are known to be reluctant).

The commissioner said that, if given the green light, he could put forward such a plan before the end of the Commission's term in office, this autumn.

In an interview with a French newspaper, Bolkestein said the time is ripe for adopting a common system of taxation of companies, as "from 1 January 2005, the 7,000 listed European companies should apply the same European accounting rules. The accounting harmonization goes hand in hand with a harmonized calculation of taxes".

"This would facilitate profitability comparisons between companies and improve transparency between countries," the Dutchman added.

Pioneer group

This would be a first step towards more transparency on taxes, likely to highlight an even larger discrepancy on rates than was thought to exist, but it would not be sufficient for France and Germany.

Aware that they have no chance of pushing ahead with a single corporate tax rate at EU level, Paris and Berlin plan to introduce it within a group of member states that wish to come on board.

According to a senior French official, this could start with four countries - France, Germany, Belgium and Spain - with the aim of extending it, in the long term, to the entire eurozone.

However, countries entering this zone risk being faced with fiscal dumping by member states that decide to stay out of it.

"We are aware of this, but we believe that being in such a single corporate tax zone has lots of advantages," said the Frenchman.

A German official echoes this view. "Imagine an Asian company wanting to invest in Europe. Would it choose little Estonia with low taxes or a large zone with a single corporate tax, of which some of the biggest countries are members?

"There are other criteria on which decisions to invest are being made: the language, the quality of the workforce, the market…"

Tax harmonization is likely to remain a remote goal as taxation is one of the last bastions of state sovereignty. But while competition will help to keep Europe's economies in good shape, small steps could be taken to deflect its undesirable effects on the provision of public goods and services, as well as to introduce transparency.

Gerhard Schröder, Germany's Chancellor, has accused some 'new' Member States of 'fiscal dumping'. France and Germany want to revive a controversial plan to harmonise corporate taxes to avoid dumping.