We’re in a mess – but it’s not EU enlargement’s fault

Germany's new Finance Minister, Peer Steinbr�ck, revived an idea that was first mooted in 2004 by the then chancellor Gerhard Schr�der and French presidential hopeful Nicolas Sarkozy: to cut EU regional aid to new member-states that engaged in 'tax dumping'.

At the time, it looked as if these statements were meant as a warning to the newcomers not to demand too much cash in the EU's forthcoming budget negotiations. So it is all the more worrying that the theme has returned, now that a deal on the budget has been done. "It is not acceptable," said Steinbr�ck recently, "that individual EU countries want more money from the EU budget without at the same time improving their domestic tax base."

"This is not fair tax competition," he added, "and it damages German jobs." Such populism has even made it into the coalition agreement between Angela Merkel's CDU and Steinbr�ck's SPD, which says: "EU regional aid should be cut for member states whose corporate tax is below a minimum threshold relating to their GDP [gross domestic product]."

The EU only has competencies for taxes that directly affect the functioning of the single market, such as Value Added Tax (VAT). Attempts to harmonise corporate taxes have persistently been blocked by the UK, Ireland and others. So threatening to punish Eastern European countries for their lower tax rates only serves to deepen the political rifts that have opened up after enlargement.

Only a minority of people now support further enlargement of the EU in France, Austria, Denmark, Finland, Germany, the Netherlands and the UK. Anti-enlargement sentiment has been fuelled by the perception that competition in the enlarged single market has somehow become 'unfair'. Cheap Polish plumbers and Latvian builders are accused of stealing jobs from Western Europe. Workers in slow-growing Germany and Italy think that Eastern Europe's economic success has been achieved by luring investment and jobs eastwards with the help of 'unfair' tax competition and 'social dumping'.

The reality in Central and Eastern Europe is very different. The widespread perception that the new members are ultra-liberal, low-tax economies that are damaging Western Europe's social systems is wrong. There are big differences between the individual countries in Eastern Europe. But generally, their levels of taxation and budget spending are only marginally lower than in most Western European countries. It is true that headline corporate tax rates in the new members are now much lower than in the EU, typically 15%-20% compared with 34%-38% in Germany, Italy and France. But this does not automatically mean that Eastern European governments are reluctant to tax local companies.

Western European tax systems tend to be riddled with exemptions so the effective tax rate on corporate profits is often much lower than the headline rate. Estimates of the effective tax rates vary widely, in the case of Germany for example from 15% to 36%.

Another (albeit similarly flawed way) of gauging the real tax burden is to look at how much money national treasuries actually obtain from companies. According to the European Commission, Germany collected corporate taxes worth only 0.8% of its GDP in 2003, and France 2.2%. Compare that with allegedly low-tax countries such as Slovakia and Hungary (2.8% and 2.2% of GDP respectively). Even Estonia, which does not tax reinvested profits at all, still managed to collect more than Germany in corporate taxes as a share of its GDP.

The perception that Eastern Europe loves low taxes has been reinforced by the fact that four of the new members have introduced 'flat' income taxes at low rates. But to make up for lost income from income tax, Eastern European governments levy very high payroll taxes to pay for their rather generous and often badly targeted social security systems. The total tax burden in the ten new members is on average four percentage points lower than in the old EU15, which is not a lot, given their much lower level of economic development.

Eastern Europeans have already gone through more than a decade of turbulent change to get ready for EU membership. The challenges they now struggle with - from ageing workforces to stubbornly high unemployment, badly targeted welfare systems and under-funded universities - are not that different from those faced by Western European countries. Western European politicians should stop exploiting populist resentment of low-wage competition. They should explain to their voters that even if Eastern Europe disappeared from the face of earth tomorrow, the old EU would still have to go through painful adjustments to cope with ageing populations and global competition from the US and Asia.

In fact, outsourcing labour-intensive jobs to Poland or Hungary helps Western European companies to stay competitive on a global scale and thus preserves jobs in Germany and France. But it takes some political courage to admit that, on the whole, eastward enlargement has been good for the European economy.

• Katinka Barysch is chief economist at the Centre for European Reform, an independent think-tank based in London.

Major commentary feature in which the author, who is chief economist at the Centre for European Reform, calls on Western European politicians to stop exploiting populist fears of competition from low-wage Member States. High-level politicians from, among others, Germany and France had accused new Member States of unfair tax competition and called for reductions in structural aid as punitive measures.