Rules of the game make it hard to catch ‘old 15’

Date: 25/11/04

By Peter Chapman

Pity the new member states. Most are growing faster than the 'old' EU 15, though to put it bluntly, they need to. But on just about every other measure of development - from the plight of their rapidly ageing populations to their jobless rates - they are far behind.

lovaks, Latvians or Lithuanians, let alone relatively well off Slovenes, to enjoy income levels considered the norm in Belgium or Finland.

Yet the ten states have just joined a long established club of rich countries that are very set in their old ways. That makes catching up especially tough.

Yes, they have been allowed into a rich internal market with huge potential benefits.

But, like any club, the EU has rules that all members must, in theory at least, abide by. Some are universally good, some bad. A few rules - such as knowing when to stay silent, as the French President Jacques Chirac put it - are unwritten.

There are pages of new laws to abide by. It is not just nitty gritty things like industry standards and state-aid rules. There are high EU levels of environmental protection that need to be taken into account.

There is also the battered and bruised Stability and Growth Pact, which just about continues to restrict eurozone members' debt and budget deficits to manageable levels that do not erode the general good of the EU economy.

In many respects, implementing these rules should help modernize the mostly ex-communist countries, at least if you agree with much of today's liberal economic orthodoxy.

But the downside is that the new countries have little discretion to do what they would normally consider necessary to give their economies a boost.

Take the massive fuss about tax competition. We are not talking about old Keynesian-style pump-priming. The countries cannot afford that luxury. We are talking about pragmatic policies designed to help countries to compete with neighbours that have better-educated workforces, better infrastructure, better access to big markets and better everything else in most respects.

France and Germany see lower rates of corporate tax in countries such as Estonia - where some firms pay 0% - as little more than a barefaced cheek.

Why should they contribute to EU structural funds that will help countries that are trying to lure their industry and jobs away with predatory tax rates?

Two finance ministers, Estonia's Taavi Veskimägi and Slovakia's Ivan Miklos, say that the corporate tax issue has been oversimplified.

“Taxation levels are impossible to measure just by rates,” Miklos told European Voice on the fringes of a recent meeting of EU finance ministers.

“The level of taxation is the tax burden and sometimes Slovakia has a lower tax rate but a broader tax base, so we have as high an effective tax burden as those countries with 25% or 30% corporate tax rates.

“The most effective way of measuring the corporate tax burden is to measure the ratio of corporate tax earnings to gross domestic product (GDP),” added Miklos.

“On this, Slovakia has a bigger tax burden than Germany; our corporate tax revenue is currently 2.2% of GDP. By IMF figures in 2002, Germany's was 0.7% of GDP.”

Polish Finance Minister Miroslaw Gronicki added that Poland's corporate tax revenue was 2% of GDP.

Veskimägi said that those member states which had criticized new EU members' corporate rates should look closer to home for the solution to their sluggish economies.

“One point we should put on the table is what the real obstacles are to the internal market and we should look at the bigger picture rather than just corporate tax. We should also consider high labour prices and over-regulation.

“Estonia has a low nominal rate but the effective rate is higher because we only have a few tax exemptions compared to Germany,” he added.

Some argue for getting rid of the structural funds rather than forcing countries to charge higher taxes.

Many tax economists argue that poorer countries must compete where their comparative advantages lie.

Lower wages and, if need be, lower corporate taxes are two ways of competing on a decidedly uneven playing field, said Kevin Hassett, a Bushite economist who specializes in tax issues at the American Enterprise Institute in Washington.

“Tax harmonization is an attempt by the more inefficient countries to stop competition. They likely pursue this strategy because they do not have the political will to change their own outmoded policies,” said the former Federal Bank economist.

Of course, the 'old' EU has been trying, since 2000, to find ways to make it more competitive while ensuring the core social protection levels that make Europe a more forgiving society for the unemployed, poor and sick than the US.

For the time being, that looks like being a luxury the new member states cannot afford.

Article discusses strategic options for the ten Member States that entered the EU in 2004 to increase their competitiveness and discusses the controversial issue of tax competition.