Cicero Policy Briefer

Issue 26, July 2008

Taxing the wealth creators: is a European solution on the cards?

By Mark Twigg

Globalisation throws up many challenges. Perhaps one of the most current is the vexed issue of how nation states should deal with the increasing potential for tax competition. In a world where economies are increasingly open to foreign ownership and where capital is increasingly mobile, there is a major quandary about how to ensure that corporates pay what politicians like to refer to as their ‘fair’ share of the tax burden. Attempts to apply the principle of fairness to situations where the tax target is highly mobile may prove to be rather like placing a square peg in a round hole. Ultimately, to speak of fair taxes does not make sense when there is nothing to stop firms moving – and taking their jobs and capital with them.

Resolving this debate is central to the development of the European economy. Not least because many parts of the EU currently operate tax policies which are increasingly less competitive in attracting foreign capital, but also because through the institutions of the European Union there is some hope that the harmonisation of tax policies could reduce the scope for competition between tax authorities. With 27 nation states now residing within the EU’s borders, there is a major prize in increasing co-operation rather than competition.

However, on this point there is of course considerable hostility to further harmonisation. In an area of policy where the EU Commission has very limited scope to impose solutions, it has been that case that while many Europeans speak a good game when it comes to co-operation, recent history suggests that politicians have other ideas in mind. Clearly, the influx of new accession states from Eastern Europe has played a major role in tipping Europe towards competition by radically transforming the corporate tax landscape within Europe. The table below shows how corporation tax rates in the newer EU Member States sit comfortably below the old ‘EU 15’.

Starved of investment for decades, these new EU Member States need to take every advantage they can in playing catch up with Western Europe. And inevitably, Western Europe is being forced to respond. It seems that these days EU countries are increasingly in engaged in a race to the bottom. The following statement by Luxembourgian Prime Minister Jean-Claude Juncker illustrates the problems Europe is facing. While Juncker is among those who speaks the language of European unity – saying a firm no to social dumping – he practices the fine art of tax competition just like any other European prime minister whose primary concern is governed inevitably by domestic issues, such as his or her country’s international competitiveness. On 28 May, Juncker stated:

“[Luxembourg] must remain competitive with other European countries. That is why the Government decided to abolish capital duty from the year 2009 – capital duty which had already been halved in 2008. That is why the Government has also decided to lower the rate of corporation tax in two stages to arrive at 25.5 per cent without broadening the tax base where possible or necessary.”

In the UK, Prime Minister Gordon Brown has signalled that the UK would like to cut the headline corporation tax rate further – it fell from 30 per cent to 28 per cent this year – though further cuts would only come when it is affordable to do so. The Chancellor, Alistair Darling, has recently established a new industry tax forum to soothe the jittery nerves of UK corporates. On the day of its first meeting, a new report published by the UK Government revealed yet more evidence that the UK is slipping behind its major trading partners in battle to remain competitive on tax. It showed that the top 185 wealth creating companies in the UK handed over 12 per cent of the added value they created in taxation in 2007. This compares to 6 per cent in Germany, 8 per cent in France and 8 per cent in Switzerland.

To make matters worse, two of the UK’s top companies – Shire Pharmaceutical and United Business Media – recently shifted their tax domicile out of the UK, a matter which is becoming a major political preoccupation in a country where the national government has recently embarked on one tax blunder after another. Of course, the debate needs to go beyond simply comparing headline rates. One must also take into consideration the impact of tax breaks, which often mean effective tax rates are somewhat lower than the headline rates. But whether the political class will properly grasp the nuance of that point remains to be seen.

Mark Twigg can be contacted on +44 (0)20 7665 9537 or click here to email.