Article

The Future of State Sovereignty and Taxation in The European Union.


By Andrea Hossó, Economist, London, UK (01/05/2019)

The tumultuous events of the past few years have put a question mark on the European Union’s future direction. The sovereign debt crisis 10 years ago, Brexit in 2016, and mounting internal and external political frictions have disrupted the integration process that German Chancellor Helmut Kohl declared ’irreversible’ in 1996.

Despite having survived the Euro crisis when the demise of the single currency was a real possibility, the EU is continuously on the brink of an existential crisis.  Brexit, Italy’s stance on budget sovereignty in open confrontation with Brussels, the rise of Eurosceptic movements and parties, and especially the sharp economic and political divergence within the EU are major disruptions to the integration project. The EU leadership faces a crucial choice: acknowledge realities and change course or continue with forced integration. The official rhetoric and the Brexit negotiations seem to suggest the latter.

Taxation has always been one of the most important economic policy areas targeted by harmonisation efforts which go back to the 1960s. In 2000, the EU Commission attempted a Code of Conduct on business taxation. In 2011, the EU Commission proposed a Directive for a Common Consolidated Corporate Tax Base (CCCTB) but it was rejected by the Council. Since then a slew of proposals has been put forward for corporate tax agreement.

In 2015, the EC reintroduced the CCCTB 'to allow companies to treat the Union as a single market for the purpose of corporate tax,…[it] would facilitate cross-border activity for companies resident in the Union and promote the objective of making the Union a more competitive location for investment internationally”. It has also been a long-standing argument that in the face of globalisation, national tax systems can’t operate and become meaningless. A case in point is the debate surrounding the taxation of tech giants such as Google and Amazon, which tend to pay a fraction of the taxes domestic companies pay.

The European Commission argues that tax harmonisation is a key element of the European single market, which is expected to facilitate cross-border flow of investment and business. Harmful and ’distortive’ tax competition is an impediment to such a unified market. The existing EU taxation landscape is quite varied; some countries, especially periphery countries, have very low rates - such as Ireland with a 12.5 per cent and Hungary with a 9 per cent rate.  Larger core countries with much higher tax rates, such as France with a unified 28 per cent corporate tax rate planned from 2020, perceived this as a competitive advantage for low tax countries, an anomaly in a ’level playing field’.

There is a new emphasis on the European effort to increase transparency and curb tax avoidance. The latter cause has become a post-crisis economic and political necessity as wide swaths of the European population, impoverished as a result of post-crisis austerity, need more support and better public services. It is increasingly viewed as a political imperative to avoid mass dissatisfaction such as the ’gilets jaunes’ phenomenon in France. Multinational companies’ low taxes have become a sensitive political issue, especially following some spectacular tax avoidance scandals such as the Luxembourg Leaks affair in 2014.

Even more importantly, a unified tax code could make it easier and more acceptable to introduce EU taxes to be levied directly on EU taxpayers (corporate and eventually individual), to be paid directly to the EU and not subject to national allocation. This thought, always present, has gained urgency with the potential departure of the UK and its sizeable EU budget contribution. A ’Eurotax’ would form a significant portion of the EU’s own resources to implement EU policies without being subject to member state scrutiny and potential interference.

The issue is fraught with problems.

There is an immediate straightforward economic problem: any attempt to harmonise tax regimes will spark political tension between core and periphery and high and low tax regime countries. Low taxes, a major incentive to attract corporate investment, are key to economic policy in Ireland and some central European countries. Countries that have mostly been competing on cheapness and tax incentives view harmonisation not only as a disadvantage but as a threat to their economic model. Ireland’s appeal against the EU’s ruling on Ireland’s favourable tax treatment of Apple is a good illustration.

The clash of individual economic interests is also present amongst core countries. The EU’s recent initiative to levy unified digital taxes has been watered down amidst opposition from a number of countries, amongst them Germany, calling for exempting digital companies from tax linked to the car industry. Further opposition can be expected from countries wanting to protect important domestic sectors.

The major issue is national sovereignty. Giving up independent taxation would wrench a crucial element of economic sovereignty out of the hand of national governments. The question cannot be considered in isolation; it is part of the entirety of the EU’s economic and political environment.

Harmonising taxes across 27 different regimes sounds logical and business-friendly. However, the problem remains the basic, fundamental structural problem of the EU economy: it consists of member states with very different economies with a wide range of development and wealth levels, and different business cultures. Introducing the Euro for such a heterogeneous group resulted in the sovereign debt crisis, which led to further divergence, as did setting uniform fiscal targets for countries with such different economies.

One-size-fits-all measures have failed before; tax harmonisation could lead to similar unintended consequences. The same measures do not operate the same way in different economies and can result in further disruption.

Even more important is the question of sovereignty and democracy. Faced with member states’ significant resistance to tax harmonisation, the EC has raised the idea of ’enhanced cooperation’, bypassing unanimity requirement. This could lead to unprecedented friction and polarisation.

Apart from the likely political fall-out, the fundamental question is whether the EU should decide tax policy for a country. French President Emmanuel Macron could not foresee the effect of his ecological tax in his own country; how can a supranational body do it better?  What happens to countries whose economic policy is radically changed this way? How would accountability be established when the tax-levying entity is not an elected national government but an unelected distant supranational body?

The issue is part of the general struggle between the European Union of nation states and the United Nations of Europe. The taxation issue will be decided in the context of where the federal project is headed. In light of Germany’s Chancellor Angela Merkel slowly leaving the political scene and President Macron suffering a considerable loss of perceived stature, this is not obvious any longer.

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