Tax – Singing in perfect euro disharmony

There is growing pressure to harmonise tax rates within the European Union. On 22 November, eleven member states launched a paper entitled ‘The New European Way’ which supported tax harmonisation. But that would be bad for business and bad for individual taxpayers.

Once EMU takes effect, different tax regimes in different member states will become one of the few factors able to sway decisions on where to locate businesses. States with high tax rates will see other states’ use of low tax rates as an unfair trick to lure businesses away. Member states outside EMU could be dragged into tax harmonisation in order to maintain a single market for the whole EU.

The argument for tax harmonisation is that there should be a single, undistorted market. All taxes distort economic decisions, changing levels of production and consumption. That is enough to reduce consumer satisfaction. The less distortion, the better.

One such distortion is the location of industry – something harmonisation would prevent.

But this argument is about the effects of a single tax system, not of several independent tax systems. Applying it to the EU assumes that the right thing to do is to have a single tax system, and that the goal of member states should be the economic welfare of all of the EU’s citizens rather than just their own citizens.

Such a shift of loyalties would break the vital link between governments and their electorates. The British government is answerable to the British electorate, and looks after the interests of the British people. If the government divides its loyalties between British and EU citizens as a whole, the result will be bad decisions and a loss of accountability.

Adopting a single tax system would deprive us of choice and would remove competitive pressures on governments. A plurality of governments is a good thing. It gives businesses a choice, and that puts pressure on governments to be efficient and business-friendly. If two governments each provide the same level of public services, but one is more efficient than the other and manages with lower taxes, the more efficient one will get more businesses choosing to operate under it.

A loss of competition between governments is likely to lead to increased tax rates, and hence increased distortion. This is because they are always tempted to do more for their citizens, to raise spending and therefore raise taxes. Acting against distortion by harmonisation will remove competition, raise taxes and thereby lead to worse distortions!

There would still be some competition between governments, because there is a world outside the EU competing for business. But the EU’s response to that threat is likely to be disastrously wrong. The European way is to ignore the fact that businesses can always leave Europe.

We can see this blindness in the proposal to impose a minimum 20% withholding tax on interest paid in one state to individuals in another state. The City of London is horrified at this idea. It would destroy the Eurobond market, taking income, jobs and tax revenues with it.

Businesses would suffer in other ways from tax harmonisation. Any tax system needs to be updated to keep it efficient. Tax systems would not be harmonised unless such detailed rules were the same across the EU.

But those rules could not then be changed without the agreement of all member states. Vital changes would be delayed indefinitely.

The harmonisers focus on corporation tax to make individuals feel safe.

But all taxes are ultimately borne by individuals. Tax on business has to be paid through higher prices, lower wages or lower profits. Lower profits hit shareholders, but in the UK that also means millions of employees with pension funds linked to shares.

I welcome government statements that it will retain the veto on tax matters and that the way to create jobs is to cut taxes, not raise them. The government must not hesitate to use it. If that makes life difficult for other members states wanting to pursue old-fashioned policies of tax and spend, so be it.

Richard Baron is deputy head of the Policy Unit at the Institute of Directors

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