Corporate tax in the EU. Tax wars

New versus old Europe

THE battle lines over corporation tax in the European Union (EU) are moving east. On one side is a pack of countries led by France and Germany which recently launched a joint initiative to harmonise the tax base for corporate taxes in the EU as a prelude to establishing minimum rates. On the other are the eight new EU members from central and eastern Europe that have joined Britain and Ireland in standing up for tax competition. Having cut their business taxes sharply to lure foreign direct investment, the newcomers are scornful of plans to set minimum (meaning higher for them) rates. Poland has turned the dispute into a national crusade, fuelled by fears that Germany and France will make disbursement of EU development aid to new members conditional on them raising their tax rates.

While this seems unlikely to happen anytime soon, as it would have to be agreed unanimously by European leaders, it is easy to see why the French and Germans are keen on tax harmonisation. The new entrants have widened the gulf between high and low business-tax regimes in the EU. According to the latest global survey of corporate taxes by KPMG, an accounting firm, the new members are leading the tax-cutting drive. Poland reduced its basic rate this year from 27% to 19%, and Slovakia from 25% to 19%. Hungary has a 16% rate, while Estonia does not even levy corporate tax on reinvested earnings. By contrast, Germany levies a 38.3% rate - at least on those firms that cannot avoid paying it - and France 34.3%.

Germany has most to fear from the central Europeans. According to the German chambers of commerce, nearly one-quarter of 10,000 industrial firms surveyed plan to shift parts of their operations abroad. While high labour costs top their list of reasons for relocating - central European wages are only 10-15% of German wages - high taxes come a close second. Siemens, an engineering giant, recently clinched a deal with its unions after warning that it might move part of its production of phones to Hungary, while Bosch, another big German firm, used similar tactics this week to extend working hours at a car-parts factory in France.

In pushing for harmonised tax rates, France and Germany hope to make central Europe less competitive - in stark contrast to the approach taken by Austria, which will trim its corporate-tax rate next year to 25%. Yet tax rates are not everything when it comes to business location: when Hyundai, a South Korean carmaker, scoured central Europe earlier this year for the best spot to build its European car plant, it chose Slovakia largely because of its good infrastructure; Poland, the runner-up, lost out because of its decrepit roads. “A 19% corporate tax [in itself] won't solve our infrastructure problems,” admits Sebastian Mikosz, the deputy head of Poland's inward investment agency.

As they fight to keep corporate-tax rates low, the central Europeans can count on strong support from Britain, which ensured at last month's EU summit that national vetoes were kept on tax. But France and Germany are pursuing their initiative through the EU's rules on “enhanced cooperation”. These let small groups of like-minded member states work together more closely in certain areas. They appear to be making headway. The European Commission is drumming up support among EU governments for a harmonised tax base for corporate taxes - currently defined differently in each member state - as a way to cut red tape and boost transparency. Even most central European governments are keen on that idea - as long as it does not lead to common rates.

• Primary Source