London wages phoney war over tax

Date: 03/12/1998

Away from the media frenzy over fiscal harmonisation, Tim Jones finds a real story unfolding

OSKAR Lafontaine should be a very proud man.

It is not often that finance ministers thrust themselves into the public consciousness. Indeed, six years ago, an opinion poll found that more Britons recognised a photograph of the racehorse Desert Orchid than could put a name to the face of Norman Lamont - the second most powerful man in the UK government.

Yet, within two months of taking office, Germany's finance minister has managed to fire up the 'Anglo-Saxon' media into an orgy of excitement, culminating in the splashing of his face across the front page of The Sun newspaper (daily readership 12 million) accompanied by the headline: 'The Most Dangerous Man in Europe'.

Lafontaine is not in the dock for urging a cut in interest rates; it is only the Frankfurt banking and journalistic establishment which considers this to be a crime. Instead, he stands accused of campaigning to integrate the EU member states' fiscal systems and forcing the post-Thatcherite British to raise their taxes, shed jobs and destroy the City of London.

Starved of political civil war over the euro ever since the Labour Party sent the Tories into outer darkness 18 months ago, the London media have pounced on Lafontaine and his tax plans. Meetings of EU finance ministers have rarely been so well-attended.

Tax harmonisation is the 'story'. The fact that eight out of 15 ministers agreed last week to a freeze in real terms in the EU's budget for the next seven years - and the profound implications this will have both for enlargement and for the Iberian twins as they enter the euro area - was not even reported outside France and the Netherlands.

This was not helped by Lafontaine's British counterpart Gordon Brown, who has obviously forgotten the maxim of 19th century UK premier Lord Palmerston that "the function of a government is to calm rather than to excite agitation".

As the newspapers hurriedly lit the tax fire, Brown reached for the bucket marked 'petrol'. Tax harmonisation was a mistake for Europe, he railed. The British government would never accept it. He had a veto and, by George, he would use it.

The trouble is that just because the British media and the agenda-setting financial news agencies have gone stark-raving mad about tax harmonisation does not mean that there is not a grain of truth to the story. There is. Tax harmonisation is coming.

However, it is coming through slow and painful evolution and not revolution. Moreover, it is coming about largely because of 'third-way Gordon' and not 'red Oskar'.

A year from now, EU governments will probably have managed to agree to take a broadly similar approach to taxing energy consumption, corporate profits and interest paid by banks to people who live in another member state.

It will be a minimalist package, unrecognisable from the grand taxation plans of Jacques Delors' Commission. Lafontaine's 'dastardly plot' - the direct result of poor translation and misunderstandings - to set a standard rate of corporate tax across the EU will not achieve fruition in anybody's lifetime.

From the early days of economic and monetary union, tax rates on corporate profits will vary from 12.5% in Ireland to 48% in Germany once state and federal levies are taken into account. The Union average is around 33%, with an arsenal of exemptions for businesses taking on staff or investing in new machinery and premises.

The British press barons can rest easy in their beds. Nobody has called for a standard corporate tax rate. The Austrian presidency of the EU suggested that the Commission should carry out a study into ways of limiting the gap between the highest and the lowest rate; something finance ministers have already done tentatively with their rates of value-added tax.

Instead of trying to align their corporate tax systems, government officials are meeting regularly with the ultimate aim of eliminating the most blatantly predatory sectoral tax regimes. These, such as Ireland's special 10% tax rate for high-skill manufacturers and financial services, are judged to be expressly designed to lure investment from other member states.

The group established to enforce the EU's one-year-old code of conduct against "harmful" corporate tax schemes - incidentally chaired by Brown's Junior Minister Dawn Primarolo - is aiming to present a definitive list of the most distortive schemes to ministers by next summer. This is hardly a teutonic assault on corporate tax sovereignty. Similarly, the energy tax deal, when it comes, will bear little resemblance to the proposal hatched in 1992 to coincide with the Rio earth summit, when the Union first pledged to stabilise and then cut carbon-dioxide emission levels.

The latest compromise paper from the Austrian presidency would allow governments to agree a 'framework directive' for governments to tax the use of energy products and set zero rates of excise duty on electricity, natural gas and coal.

As if this were not bland enough, exemptions would be granted to "energy-intensive industries and firms which meet targets for energy efficiency" along the lines established by Lafontaine for Germany's big fuel consumers. To make the long-sceptical British happy, domestic fuel-consumption would be exempt for an as-yet-undefined period. Given that Brown has now accepted the principle that businesses should be taxed for consuming energy following the advice contained in a report from British Airways Chairman Colin Marshall, the household-fuel exemption should be enough to let him sign up.

Overall, the energy tax deal would mean that all member states accept the principle that energy consumption should be taxed without actually having to do it.

It is less obvious how Brown's opposition to the European Commission's plans for a tax on cross-border savings income will be bought off. Internal Market Commissioner Mario Monti hopes this can be done by promising a campaign to open up the EU's capital markets, but that is an even longer game than tax harmonisation.

Yet, even in the area of savings, the 'story' is exaggerated beyond recognition. Ten-year-old Commission plans to introduce a common 15% tax on interest have been dumped.

If the latest proposal is approved by all 15 governments, financial institutions would have to withhold 20% from the interest 'coupon' paid to non-residents or provide details of interest paid to that saver's home tax authority. All debt instruments - bonds as well as bank deposits - would be covered if they were in the name of a non-resident.

This is the tricky bit. Traders of debt instruments denominated in currencies other than that of the issuer - known as 'eurobonds' - warn that this new tax regime would drive this 3-trillion-ecu market out of London and into the arms of New Yorkers.

Like all the worst scientific claims, this one cannot be proved either way. The British treasury is more likely to concentrate its efforts on rectifying a genuine problem with the proposal; namely, that it could transfer up to 4.5 billion ecu from investors to eurobond issuers.

When eurobonds are issued, they include a clause that if a withholding tax is introduced during a bond's lifetime, the issuers themselves will assume the extra cost - a practice known as 'grossing-up'.

However, to insure themselves against this, issuers include a clause in the contract insisting on their right to pay off the bond in full at the price at which it was offered. Since bonds are now trading above their issue price, issuers will be sorely tempted to pay off their bonds and accrue a 4.5-billion-ecu windfall.

Dealing with this problem is a 'real-world' task for British negotiators. For a still-nominally Socialist government to fight to the death for the rights of billionaire eurobond-holders will be as hard to justify as freeing Augusto Pinochet.