Damon Lambert

Despite the so-called red line that taxation is a Member-State issue, there have been several moves recently towards a fiscal straitjacket for EU governments in terms of how, or even if they raise taxes, all under the EU terminology of EU harmonisation. The fact that sovereign states still have control of their own tax-raising abilities is already only a half-truth; VAT is in creation an EU tax, driven by EU directives, the EU Savings Directive has been introduced to standardise the taxation of interest and the ECJ has unilaterally declared that it has the power to widely interpret the general freedoms defined by the EU Treaties to remove large chunks of Member States tax legislation.

There is increasing pressure from some quarters, notably the higher tax jurisdictions of western continental Europe, and the European Commission with its desire for a single European Union tax base, for tax rates to be "harmonised" or, more correctly, standardised across the EU. The intention is to counter the low corporation tax in countries such as Estonia and Ireland that has assisted these in their pursuit of economic growth.

This article considers the rationale, impact and future of tax harmonisation for the EU member states.

Harmful tax practices and unfair tax competition, generally regarded as low tax rates applied by states such as Ireland and Estonia as well as offshore locations, have long been under attack from the EU. Ireland is a glowing example of how a low tax rate on corporate profits (as low as 10%, now 12.5% compared to Germany's 40%) can be a catalyst for economic growth.

So-called "harmful tax practices" attract capital and reward successful businesses. Higher tax rates do the opposite. They are the ones that deserve the epithet 'harmful'.

Bizarrely the EU's direct tax policy, as illustrated in the Tax Code of Conduct, seeks to prohibit low not high taxation. If Ireland's low corporation tax rate has turned them from the EU's economic sloth to its economic tiger, surely the answer should be that the rest of the EU should copy Estonia in seeking to emulate Ireland and congratulate them on confounding established opinion in reducing its tax rate and boosting its economy.

The same impact can be seen in the field of savings taxation. The purpose of savings taxation is to impose a standard rate of taxation on individuals' savings and is an attack on offshore bank accounts and the Eurobonds market that exists in the UK whereby companies can issue debt and pay interest without having to withhold income tax. It is also the opposite approach to that which the US is implementing. In contrast to the competitive US the EU is seeking to penalise the financially sagacious. Yet the debate on the introduction of this directive was narrow and limited, and did not even raise the fundamental question of why should savings income, primarily the result of post-tax earnings, even be taxed in the first place. Such a measure will discourage investment from outside the EU, and drive EU citizens to invest more heavily overseas, removing capital from Europe.

The EU's approach is driven by three erroneous concepts.

    The EU sees tax collection as a net sum game
    It is not and it never will be. Ireland has attracted a lot of investment that would not have come into the EU at all if it had not been for their low tax regime. Also a tax regime that does not punish profit is always likely to produce more wealth and more jobs than a high-tax regime. The tax paid on marginal profits is an important incentive these days in determining the location of capital, especially as capital is far more mobile than, say, humans or real estate, which have greater inelasticity in the proportion of the tax burden they can take. If businesses are truly getting more mobile then fiscal reasons will have a greater influence in determing the location of capital, and pushing tax rates up will only encourage capital to flow outside the EU.
    The dominant political forces in the EU believe in high tax rates
    They believe that governments can spend money better than successful businesses. Although not a perfect test, a company's ability to earn profits, is a pretty strong indicator of the ability of that company to create sustainable jobs, stimulate competition and drive forward that country's economic welfare. If Ireland's 12.5% tax rate is preferable to Germany's 40%, then why not go that one step further consider the impact of whether a zero tax rate on profits would be even better. Carl Mortishead in addressing the Bruges Group recently foretold the end of tax on company's profits, possibly, as a result of ECJ activity; if only the author could share his optimism.
    The EU's inability to recognise the benefits of diversity
    The 'one system suits all' approach does not allow jurisdictions to adapt their economies to their separate needs. What a country that was communist 15 years ago might require from its fiscal system may be somewhat different to what, say, the UK or Germany might require. Diversity allows different states to try alternative systems of taxation, and from that experience preferred regimes should emerge in each of the 25 Member States. Tax harmonisation would prevent intra-EU comparisons of whether it is best to tax labour, capital, profits etc. Indeed under tax harmonisation, it is hard to imagine that the stellar performance of Ireland in the last 10 years would ever have happened.

So, will the EU forego its desire for tax harmonisation? It is most unlikely, especially with the blinkered approach of those in the EU who see the State as the prime source of inspiration. The risk of the EU introducing tax standardisation is increasing. The EU Constitution creates more room for low tax rates to be attacked, especially given the ECJ's ability to reinterpret the EC treaty to mean what it wants it to mean. The poor drafting leaves the door wide open for a push to punish those who seek not to impair the efficiencies of their economy with high taxation.

There also exists a desire to remove the distortions of the internal market that State aid produces and already the EU has attacked certain tax incentives as being State Aid. How long before Estonia or Ireland are attacked for State Aid in not taxing hard enough or for distorting the internal market? The intention of the EU Commission is clear. The EU should not acquire any more power over taxation and, indeed, should lose what it already has. But those red lines that Tony Blair has been boasting about are fading away.

Is tax harmonisation therefore a bad thing? Whilst doubts must be reserved about a single system for 25 countries, with diverse economies, there must be some merit to tax harmonisation were its overall impact to lower taxes, reward enterprise and move to a greater rate of tax on transactions instead of earnings and profits.

What makes tax harmonisation particularly harmful is the fact that the underlying aim is to remove low taxation, impose standard high taxation rates and to tax areas that influence the location of that most mobile of resources, capital. Continuing with this policy will most probably result in less, not more investment in the EU, whether from internal or external sources, and ultimately less efficiency and prosperity.

What should Britain do? My tax agenda for the UK, assuming exit from the EU or renegotiation of our membership, would be as follows:

    Reduce the tax burden. 42% is far too high a proportion of our GDP to be entrusted to the inefficiencies of the public sector.
    Repudiate the EC Savings Directive and return a system that suits the UK's capital requirements. If the Continental European governments want to impose greater taxation on their nationals' savings accounts, that should be their problem not the UK's.
    Abolish corporation tax, or slash the rate significantly to attract investment and reward return. Despite our headline rate of 30% being one of the lowest in the EU, figures from Eurostat reveal that the calculation of taxable profits is such that the UK government from 1998 to 2002 collected more tax on company profits as a percentage of GDP than anywhere else in the 15 others than Luxembourg.
    Move the tax burden more to transactions and labour, which are typically more inelastic in their capacity to absorb tax.

This is Damon Lambert's personal opinion and should not be viewed as the policy of KPMG LLP