The Debate: Lower tax rates for new EU members

It’s not unfair – just a bad tax

By Michael Devereux

The average corporation tax rate in OECD countries is roughly 35%. The UK rate is 30%. Is the UK being unfair to other countries? Suppose Gordon Brown announced in his next Budget that to attract more inward investment he was cutting the rate to 25%, or 20%? Would that be unfair? The answer in both cases must be ‘no’.

Our apparently pro-European government has refused to compromise on the principle that unanimity is required for agreement on EU tax measures. The political basis of this position is clear: the right to set taxes is a central part of national sovereignty.

So on political grounds, it is hard to argue that lower tax rates in accession countries are unfair. They have the political right to set whatever tax rates they see fit.

The economic basis for independence in tax-setting is less clear. In the early 1980s, the average corporation tax rate in the OECD was nearly 50%. A plausible explanation for the remarkable fall over two decades is the prevalence of competition amongst countries to attract investment.

The UK does not set its corporation tax rate in isolation, as the government well knows. Gordon Brown’s Budget speeches over the years have boasted about how relatively low the UK rate is. On the other hand, we have lived with even lower corporation tax rates amongst our neighbours for many years – Ireland has had a special tax rate on manufacturing of only 10% since the early 1980s.

The real issue about corporate tax competition is not whether or not it is unfair. It is whether we would be better off by agreeing to maintain a certain level of corporate taxation, and requiring accession countries to do likewise.

But whether that is beneficial depends on whether corporation taxes are an economically efficient way to raise revenue, compared to other taxes.

Generally they are not – they distort location decisions, financial decisions and investment decisions, and they create huge compliance problems. Why should we object if other countries want to rely on such taxes rather less than we do?

  • Michael Devereux is chair of the department of economics, University of Warwick

…and the new states will cut it
By Dr Martin Manuzi

The party atmosphere of the ‘Enlargement Day’ celebrations in Brussels, which marks the entry of 10 new EU states, is unlikely to continue for long – not least because of issues such as the low tax policies of the accession countries. A fair number of the ‘old’ EU member states regard such policies as unfair competition. But the view in Brussels is that the ‘unfair’ argument could cut many different ways.

At the heart of the problem lies the wider dilemma of structural economic reform – or rather the lack of it – in the largest economies of the European Union. According to some, the opposition to the ‘low-tax, high inward investment’ strategies of the accession countries originates directly from the political reluctance of the more mature EU economies to tackle long-standing welfare, pension and other commitments. All this despite the rhetoric on the so-called Lisbon Agenda.

There has been much admiration of the ‘Irish formula’ for economic success and the potential in using low corporate rates to draw in industry and services. However, the Irish formula was also dependent on EU funds for vital infrastructure. But, these days, the largest contributor to the EU budget is rather less forthcoming than it has traditionally been.

One thing is clear: the accession countries will fight their respective corners. They will do so in the knowledge that the era of large cohesion and redistribution policies at the EU level are pretty much over. Let’s not forget that the entire EU budget represents only around 1% of EU GDP.

Is it likely that the accession countries will give up their principal tool for attracting investment for an additional fraction of a fraction?

As Europe’s economic history proves, the competitive advantage of cheaper labour markets and, frankly, lower expectations in relation to social and public infrastructure, tend to diminish quite quickly. If nothing else, the Brussels world is a centre of diplomatic excellence and pan-European understanding. Viewed from this perspective, the main message seems to be: ‘what other formula can we expect these countries to adopt?’

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