The uncertain journey towards fiscal harmonization

The entry into force of the so-called “Fiscal Compact” is one of the steps towards an increased harmonization of economic policies among the members of the euro club.

After having approved rules on the spending side which will substantially affect the room for maneuver of any national government, the next natural step could be further integration in the area of taxation. In addition, the recent fiscal scandal regarding the massive evasion/avoidance of corporate taxes by global corporations has highlighted the weakness of the single market. It has also made room in the political agenda to tackle the issue of taxation policy at a community level. 

The EU executive has denied rumors concerning an upcoming plan to introduce some sort of harmonization of national tax rates with an overall increase, but as recently stated by the Commissioner in charge of tax affairs, Algirdas Šemeta, “The day of isolated tax policy is over. Coming closer together as a Union on tax matters does not threaten member states’ sovereignty”. Furthermore, the EU executive has also asked member states to end “the harmful tax competition”, and a proposal to harmonize the tax rate in Europe was planned in 2011 but never released to the public.

Of course, something is moving in Brussels. The sovereign debt crisis and national austerity plans have increased the necessity to improve the capacity to address tax dodging. The European Commission estimates that tax evasion and avoidance amount to around one trillion euros each year within the EU. To reduce this massive scale of tax evasion, the EC has recommended that member states implement an “aggressive tax plan” to reduce the “national mismatches and loopholes (which become) the playthings of those that seek to escape taxation”. The incomplete nature of the single market has permitted businesses to “structure arrangements with such jurisdiction via the member states with the weakest response” leading to unfair competition between businesses.  

The few competences retained at the European level, principally related to VAT rules and administrative cooperation, are seen as insufficient to effectively implement a European action to reduce tax evasion and introduce some sort of tax harmonization. In addition, taxation is one of the few policy areas in which any one country has the power to block any change by vetoing a proposal. Indeed, Viviane Reading, Justice Commissioner, declared, “The veto right in the EU Council has to be scrapped. Qualified majority voting should be extended to more policy areas, for instance taxation”.

This declaration is a clear indication of the political battle ahead in the coming months. The European agenda will deal with three important dossiers during the current Irish presidency: the savings tax directive, common consolidated corporate tax base (CCCTB) and the financial transactions tax (FTT).

If the financial transaction tax is a provision from which member states have the option to opt-out (and many have already chosen this option), the common consolidated corporate tax base (CCCBT) will be a much more complicated issue to solve. The Irish PM, Enda Kenny, accused the Commission of using the proposal to introduce tax harmonization “by the back door”.

Corporate taxation has always been a critical issue in Europe. Aggressive cuts in corporate tax have been seen as a form of “fiscal dumping” among states.

France and Germany have always openly criticized countries with lower rates of corporate tax within the single market, accusing them of “unfair competition”. Ireland has been the country most often attacked in the past for its 12.5% corporate tax rate. Also, during the bargaining to conclude the bailout and save Ireland from financial default in 2010, France and Germany tried to insert in the bailout deal an obligation to increase the corporate tax rate in Ireland. Despite huge pressure from its partners, Ireland held out and obtained the bailout without changing its fiscal policy. Nevertheless, in 2012 Germany and France tried to convince Ireland to increase its corporate tax rate in exchange for lowering the interest rate to be paid for the bailout.

Ireland is not the only EU country accused of “fiscal dumping”. Cyprus and Bulgaria have faced the same accusation. Cyprus needs a bailout agreement, but as happened with Ireland, it has been postponed by Germany, with the declared intention to push Cyprus to accept a radical change in its fiscal policy, starting with the corporate tax rate.

Portugal could be soon part of the list of countries accused of fiscal dumping. Indeed, it announced a plan to cut its corporate tax rate from 25% to 10%, a lower rate than Ireland. The reform announced by the Prime Minister of Portugal, Pedro Passos Coelho, needs to be approved by the Troika (IMF, EU and ECB). This proposal is opposed by France and Germany who are blocking the measures in order to avoid a race within the EU to cut corporate tax in this difficult time for the public finances of many European states.

It is clear that there is a political battle coming. France and Germany, but also Italy and the Nordic countries, are preparing the ground for the introduction of the harmonization of tax legislation. The Commission’s proposal concerning the CCCBT is a step towards creating a harmonization that will allow freedom of choice concerning tax rates for member states, but that will also limit  opportunities multinational firms have of abusing loopholes in the fiscal legislation.

Fiscal harmonization within the European Union is not so straightforward. The division within the European Council continues and space for a deal is almost non-existent at the moment. The rules of the game give a strategic advantage to Ireland in the battle to keep the status quo. Ireland is the country which has gained more from the corporate tax rate war and an exit from the bailout plan before the summer will reduce its exposure to retaliation by other European countries. Othercountries that are hostile to the harmonization plan are not in the position to table a veto without fear of dangerous retaliation: Cyprus is still looking to receive a bailout and Bulgaria will not fight to the end to avoid harmonization.

Tax harmonization is a necessary step to further implement the single market, and austerity and the sovereign debt crisis have catalyzed the process. To overcome the impasse and the veto powers of some countries, EU member states and the EU Commission are opting for enhanced cooperation, which will allow single states to move towards strict cooperation within community rules. Another, more feasible option is the introduction of a common rule concerning tax collection. This option will be more easily approved by the Council but could be ineffective. Most likely, thus, tax harmonization at the European level is really coming at an increased speed.