Ozvěny z Opletalky

Incompatibility of 27 tax systems in the EU poses compliance costs and market distortion. Common consolidated corporate tax base is proposed as a solution. However, small countries see it as a threat to their tax competition activity. I offer an insight into both connected issues.

One of the ideal features of single market is that national tax structures do not affect behaviour of economic agents. Unfortunately, this is not the case of a group of 27 economies in the EU. Under an extreme interpretation of the Treaty of the EU and its provisions about free movement of capital, it would be impossible to keep separate tax systems. Nonetheless, the general view allows for separate tax systems as long as they manage to avoid double-taxation and to tax all firms in the source country in the same way. (Griffith, pg. 21) However, sometimes they do not manage it: the judgements of the European Court of Justice have already changed national tax policies in several issues of unfair tax treatment. (OECD 1, pg. 4)

Broadly speaking the European Commission (EC) does not intend to harmonise tax systems across the EU.[1] It is so because differences between tax systems are not a problem as such. The real difficulties arise from incompatibilities which lead to the organizational problems. (EC Tax 4)

Corporate income tax (CIT) rates are not bound by any rules. Capital, contrary to labour, is much more internationally mobile, and governments naturally try both to lure it to their domiciles and not to scare away the existing capital. Eventually, they have engaged in competition for capital in the form of offering state aid and tax incentives for foreign direct investors. The decision of firms where to locate their business then might be determined by differences in tax rates rather than differences in efficiency of production. In terms of economic criteria this leads to inefficient levels of production within the EU. (Swann, pg. 70)

By now, we have established two areas with a kind of distortions. We will look at them closely. Let’s review development in taxes in general first.

EU induced distortions

Let‘s sum up briefly the main tax-related companies‘ obstacles to cross-border business. Note that they often stand against the Treaty of the EU. (EU tax 2, pg. 223-305).

• In many areas, double taxation occurs as a result of conflicting taxing rights.
• Member States are reluctant to allow tax relief for losses incurred by associated companies whose profits fall outside the scope of their taxing rights.
• Principle of separate accounting requires costly transfer pricing (definition in Appendix).

As a long-run strategy to tackle these issues, the EC proposed to provide companies with a common consolidated tax base for their EU-wide activities. Four different solutions were proposed:

• Home State Taxation scheme for small and medium sized enterprises,
• Common Consolidated Corporate Tax Base (CCCTB),
• European Union Corporate Income Tax and
• Compulsory Harmonized EU Tax Base.

The EC is currently working on the first two projects. (EC tax 1) The draft legislative proposal for CCCTB was supposed to come out in Autumn 2008, but has been delayed. (ITR 1)

CCCTB, contrarily to the currently active principle of separate accounting, is based on the notion that a group of companies form an economic unit which forms its single consolidated tax base across all states in which it is active according to harmonised rules. The tax base is then apportioned between the different Member states according to a formula, which has not been yet specified.[2] (Spengel, pg. 9)

CCCTB is supposed to eliminate the main tax obstacles to cross-border business activity, for taxation would no longer be based on the principle of separate accounting. Put in the words of the EC, „the offsetting of profits and losses would be immediate, obstacles to corporate reorganisations would be virtually eliminated, domestic investment would no longer receive preferential tax treatment, and the administrative costs would be sharply reduced, as would the risks of double taxation.“ (Aujean, pg. 30)

The group of CCCTB opposing states (e. g., Britain, Estonia, Lithuania and Slovakia) is led by Ireland. (ITR 2) Let’s name their main arguments. (Dodwell).

• Countries can end up with smaller tax revenue.
• An example is the UK with tax base wider than in other EU countries (see Table 1 which illustrates the importance of the breadth of tax base).
• The apportioning formula embeds preferential treatment to large countries. The biggest controversy spreads around the sales criterion. The EC prefers to measure sales at destination over origin. This method prefers large countries with larger consumption over small countries.[3]
• CCCTB requires a common specification of tax (consider variability of allowances and incentives).
• Since tax collection is based on tax base, some people see this as a step towards currently controversial tax harmonisation. Note that even the public relations side of the argument is important.
• Governments would lose a fiscal policy tool (the depreciation allowances) which stimulate investment. (RGE)
• Possible optionality of CCCTB would impose administrative burden on states by the need to run two tax systems. Some people speak about limited rationality of optional CCCTB (see footnote #4).

Let’s note that tax issues in the EU are legally processed under consultation procedure, i. e., the decision lies in the hands of the Council of the EU whose decision has to be unanimous. (Wikipedia) However, the EC plans to push CCCTB through via the principle of enhanced cooperation, making it an optional scheme.[4]

Table 1: High tax rates don’t necessarily mean a high tax take (1999-2003)

	Tax rate	Tax revenue to GDP
Germany	39%	1.3%
France	34%	2.9%
UK	30%	3.3%

Source: Dodwell

Let’s describe now the competition for mobile capital in the EU. According to the paper I use as a major source, it is small countries who are the leaders of the competition. The small countries stance towards CCCTB has already been described. They argue that CCCTB will eliminate the advantages offered by their business environment in favour of bigger states. For example, the EU opposing think tanks in the Czech Republic emphasize that CCCTB significantly eliminates tax competition.[5]

Tax competition

Tax competition has traditionally been considered by economists as welfare-lowering. The major argument against tax competition has been that it leads to inefficient allocation of productive resources and mainly public services. However, eventually a shift in standard model occurred and governmental use of resources stopped to be considered as strictly efficient. Instead, it might be better to „tame the Leviathan“ a.k.a. Government, i. e., reduce the resources used in an inefficient manner. (Douglas, pg. 1). Let me sum up main problems associated with tax competition (also called „the race-to-the-bottom in capital tax rates“).[6] (Eurostat 1, pg. 87):

• Eurostat confirmed that tax competition eventually leads to the shift of tax burden on less mobile (less elastic) factors like labour, consumption and real estate. (Hoek, pg. 27). As the reasons of this change in tax-mix, Eurostat names increased capital mobility and the accession to the EU of a group of low-tax countries. (Eurostat 1, pg. 11)
• Given that capital is, as a rule, both more lightly taxed than labour income and often taxed at flat rates, equity considerations warn that progressivity of the income tax may even diminish for individual holders of capital.
• Tax competition may eventually lead to the evaporation of CIT. Then all arguments for the existence of CIT may be applied. The main reason why to keep CIT is that it plays an important withholding function because it reduces the tax-induced incentives for businesses to incorporate and to shift from highly-taxed labour income into lower-taxed capital income (so called backstop function of CIT to personal income tax).
• Tax competition gives rise to political frictions. Net payers to the EU budget say they „finances unfair tax competition against itself and face tax dumping.“ (Barysch)

Chatelais (pg. 6) shows that small countries[7] initiated a very significant tax-cutting process which intensified after year 2000 (see following figure). Big countries reacted only moderately. Why? Chatelais (pg. 3) say that the ratio of the capital transfer and GDP in case of small countries is high enough to „largely offset the initial loss of tax revenues“.

Source: Chatelais (pg. 6) using OECD, EC.

In the econometric estimation of their model of tax competition in Europe, Chatelais found presence of strategic interactions which are motivated by the importance of foreign capital.

They show that countries observe their neighbours tax rates and respond with their tax rate the following year and more than proportionally. Looking more deeply, they found that countries react strongly to neighbours’s behaviour and that distant countries react to core countries (Ireland, Belgium, the Netherlands, Luxembourg, Denmark, Austria, Slovenia and the Czech Republic) behaviour by sharper changes in order to compensate for the missing agglomeration effects. In the group of small countries, only those close to the center play a significant role in corporate tax rate setting of large countries. Finally, Chatelais found that it is Ireland and Belgium who can be considered as individual leaders for major countries.

Conclusion

As was the already solved monetary question, tax field is pain in back of the EU’s economic integration. In my opinion, the tax-task is very difficult. I think we all are prisoners who have a dilemma. We all have by far imperfect information about pay-offs of harmonised tax policy, some of us doubt good intentions of big players like France and we are reluctant to lose evem a penny of tax revenue and FDI. The way towards social optimum of a group of prisoners is seriously difficult. Compared to euro, we are getting on thin ice because we manipulate with (clearly visible) flows of money. That moves this policy issue to a much higher level: the political one. And finally, the issue represents a giant step in the integration of the EU.

The topic of CCCTB has regrettably been virtually untouched in the Czech media but I think it is a time-bomb of public discontent. Especially in the Czech Republic.

Personally, I am happy about the positives of CCCTB and I believe them. On the other hand, I do not know how big they are. I also do not know what is the cost of running and getting to run CCCTB. And I am afraid that no one will ever know this. Maybe it is the reason why I would prefer to go the way of evolution rather than revolution of the tax system.

I am happy about the fact that tax competition exists because I think lowering tax rates is a fundamentally good thing. Yes, the discontent of large countries is understandable because we all are greedy. And it is equally understandable that small countries will fight to keep their current rights. I think they understand CCCTB as an effort of large countries to actually steal their money. If the stance that large countries like France and Germany want to actually rob smaller countries becomes widely held, CCCTB may significantly decrease popularity of the EU.

I am curious whether the next generation will advance in the stance towards the EU integration. Whether the people will ever really want to integrate… Well, let’s leave the field of cheap talk… It all depends on money. Give us the money (advantages of the integration) and we will happily integrate. ■

Appendix

What is transfer pricing?

A definition (EU tax 2): Affiliated companies conducting cross-border business must behave on strictly market principles, i.e. act as if the business was being conducted between independent parties. The charged price–the transfer price–therefore has to be in accordance with the so-called arm’s length principle („I don‘t know you, my brother.“). The basis for the arm’s length principle is the separate entity approach; i.e. each affiliated company in a group is for tax purposes treated as a separate entity and taxed individually. For the Internal Market this means that a company has to provide separate accounting for every Member State where it is active.

What are recent trends in taxation in Europe?

The European Union is a high-tax area. In 2006, the overall collected tax (tax and social contributions) in the EU-27 amounted to 39.9 % of GDP, 12 percentage points above United States and Japan. CIT rates have been falling since the second half of the 1990 and they vary substantially within the Union, rising from 10 % (in Bulgaria and Cyprus) linearly to 35 % in Malta. (Eurostat 2, pgs. 3,

In order to compensate for revenue lost through reduced CIT rates, most countries have broadened their CIT base by implementing less generous tax depreciation allowances and by eliminating special tax deductions and provisions. The average effective CIT rates have nonetheless declined over time across the OECD. From 1982 to 2004, tax revenue from CIT as a share of GDP decreased only in Japan, the United Kingdom, Italy and Germany. (OECD 1)

Source: Eurostat 2, pg. 9.

References

1. (Swann) Dennis Swann. "Single European Market Beyond," Routledge, 2002.
2. (Hoek) M. Peter van der Hoek, 2003. "Tax Harmonization and Competition in the European Union," Taxation eJournal of Tax Research , ATAX, University of New South Wales. Available at <http://ideas.repec.org/p/nsw/discus/52.html>.
3. (Chatelais) Nicolas Chatelais & Mathilde Peyrat, 2008. "Are small countries leaders of the European tax competition ?," Documents de travail du Centre d’Economie de la Sorbonne, Université Panthéon-Sorbonne (Paris 1), Centre d’Economie de la Sorbonne. Available at <http://ideas.repec.org/p/mse/cesdoc/bla08058.html>.
4. (Spengel) Christoph Spengel & Carsten Wendt, 2007. "A Common Consolidated Corporate Tax Base for Multinational Companies in the European Union, Some Issues und Options," Working Papers 0717, Oxford University Centre for Business Taxation. Available at <http://ideas.repec.org/p/btx/wpaper/0717.html>.
5. (Griffith) Rachel Griffith & Alexander Klemm, 2004. "What has been the tax competition experience of the past 20 years?," IFS Working Papers W04/05, Institute for Fiscal Studies. Available at <http://ideas.repec.org/p/ifs/ifsewp/04-05.html>.
6. (EC Tax 1) European Commision’s website on taxation, available at <http://ec.europa.eu/taxation_customs/taxation/gen_info/index_en.htm>.
7. (EC Tax 2) Company Taxation in the Internal Market; European Commision Staff Working Paper, SEC(2001)1681, 23.10.2001. Available at <http://ec.europa.eu/taxation_customs/resources/documents/company_tax_study_en.pdf>.
8. (EC Tax 3) Communication of the Commision COM(2006): Co-ordinating Member States’ direct tax systems in the Internal Market. Available at <http://ec.europa.eu/taxation_customs/resources/documents/taxation/COM(2006)823_en.pdf>
9. (EC Tax 4) FAQ on EC‘s position on taxation and qualified majority voting. Available at <http://ec.europa.eu/taxation_customs/taxation/gen_info/conference/index_en.htm>
10. (Eurostat 1) Taxation trends in the European Union 2008, full text. Available at <http://ec.europa.eu/taxation_customs/taxation/gen_info/economic_analysis/tax_structures/index_en.htm>
11. (Eurostat 2) Taxation trends in the European Union 2008, main results. Available at <http://ec.europa.eu/taxation_customs/taxation/gen_info/economic_analysis/tax_structures/index_en.htm>
12. (ITR 1) An article "European Union: European Commission’s proposal for CCCTB delayed"at the International Tax Review website. Available at <http://tinyurl.com/dagdnq>.
13. (ITR 2) An article " CCCTB proposal date is in doubt" at the International Tax Review website. Available at <http://tinyurl.com/cq6ls8>.
14. (OECD 1) OECD’s Policy Brief: Reforming Corporate Income Tax. July 2008. Available at <http://www.oecd.org/dataoecd/30/16/41069272.pdf>.
15. (Barysch) Katinka Barysch, Is Tax Competition Bad?, in Centre for European Reform (CER) Bulletin issue 37, August/September 2004. Available at <http://www.cer.org.uk/articles/37_barysch.html>.
16. (Douglas) Wilson, John Douglas & Wildasin, David E., 2004. "Capital tax competition: bane or boon," Journal of Public Economics, Elsevier, vol. 88(6), pages 1065-1091, June. Available at <http://ideas.repec.org/a/eee/pubeco/v88y2004i6p1065-1091.html>
17. (Aujean) Michel Aujean & Marie Pierre Hoo, "An outline of the CCCTB and some focal points". Available at <http://tinyurl.com/cj4bj4>
18. (Dodwell) Bill Dodwell, "The CCCTB – is it a dream or a mirage?". In a newsletter of the Chartered Institute of Taxation, 2008. Available at <http://www.tax.org.uk/attach.pl/6688/7833/007_TA_0408.pdf>.
19. (RGE) Daniela Schwarzer, "The downsides of harmonising the EU corporate tax base", 2008. Available at <http://tinyurl.com/c3bcql>.
20. (Wikipedia) An article on Consultation procedure. Available at <http://en.wikipedia.org/wiki/Consultation_procedure>.

---

[1] There is one notable exception, written already in the Treaty of the EU. Different indirect tax rates would constitute an immediate barrier to the free movement of goods and services.

[2] The apportioning formula is used in the USA and Canada. The mechanism is that international firms use only one tax base defined by the EC (instead of more in case of separate accounting). The base is apportioned among the states where the firm operates according to the formula. Then each country applies its CIT rate. In the EU, a three-factor approach is currently suggested for the formula, based on labour (payroll and number of employees), tangible assets and sales. (EU tax 2, pg. 410; Dodwell)

[3] An excellent survey of the Irish arguments and current political support across the EU is provided by a study by Hume Brophy (2008) available at <http://www.humebrophy.com/news/publications/>. The position of the EC on the sales criterion is described in its working paper (2007) available at <http://tinyurl.com/dltah3>. The international experience with apportionment is described in a presentation from the UConn EC Tax Symposium (March 2008) available at <http://tinyurl.com/c7o9va>.

[4] The Chartered Institute of Accountants in Ireland argues that „if CCCTB were to work at all, all Member States would have to join the party“ (02/2009). Available at <http://tinyurl.com/dy86px>.

[5] EUportal <http://tinyurl.com/clbzcb> and The Liberal Institute <http://tinyurl.com/d3ln7z>.

[6] Note that in this essay I do not write about positive effects of tax competition (see Douglas for review of this difficult discussion).

[7] The division is based solely on area, not GDP.

This article is an essay on European Economic Policies, a course at IES FSV UK, submitted in April 2009.

Illustration taken without permission from Praise Be to Tax Competition! on Mises.org.

 

Článek napsal/a Radovan Fišer dne 19. 5. 2009. Je uložen v rubrice Články a má tyto tématické štítky: CCCTB, tax competition, tax harmonisation. Komentáře k článku můžete sledovat pomocí kanálu RSS 2.0. Za váš komentář budou čtenáři i autor/ka článku vděčni.