The downsides of harmonising the EU corporate tax base

authored together with Sebastian Dullien 

The French Finance Minister Christine Lagarde last week announced that Paris would use its Presidency of the European Council starting on July 1, 2008 to push for a common corporate tax base. Despite its looks, this is yet not another brand new initiative by Nicolas Sarkozy – in addition to the other French EU Presidency priorities in the fields of European Security and Defence, Environment/Climate Change, Energy, Immigration and the Union for the Mediterranean.

The harmonisation of the tax base has been on the EU agenda for very long. Since its corporate tax strategy of 2001, the European Commission has pushed for abolishing tax obstacles in the European Single Market. It organised expert conferences in Brussels (2002) and in Rome (2003), created the Common Consolidated Corporate Tax Base Working Group in 2004, invited business groups to participate in 2005. In 2006, pushing for the realisation of the growth and employment targets of the Lisbon Strategy, it called for greater coordination among member state tax systems. Under the German EU Presidency in May 2007, stake holder discussions were held with the Commission on this issue in Berlin. More importantly, the German Finance Minister Peer Steinbrück took the issue into the Ecofin twice for political discussions during his EU Presidency, after preparations of the Council meeting on the diplomatic level had yielded no compromise. Germany had said in its EU Presidency work programme that the commission’s project for introducing a single tax base for company taxation “is to gain further ground . . . so that the Commission can submit its legislative proposal in 2008, as envisaged.” At the moment, an impact study is conducted.

Not all member states back the Commission’s work as visibly as Germany and France do, and they will complicate the French initiative in autumn 2008. One of the most outspoken opponents of the Common Tax Base is Ireland (not only the government and the industry, but also the Irish Internal Market Commissioner Charlie McCreevy). The Irish opposition is said to be one of the reasons why the Commission’s plan will only be presented in the second half of 2008 and under the French EU Presidency – in order to prevent that the Irish referendum on the EU Reform Treaty is taken hostage for a possible tax move which is unpopular in Ireland. Political reactions from Ireland to Lagarde’s announcement last week gave evidence of the political sensitivity of this issue for Ireland just before the referendum on the Lisbon Treaty; some were violently opposed, others simply downplayed the feasibility of the tax base harmonisation in the EU-27 due to the need to adopt this decision by unanimity.

Other countries that seem to oppose a harmonised corporate tax base are Cyprus, Estonia, Lithuania, Latvia, Slovakia, and the U.K. Like Ireland, they argue that harmonising the tax base is a likely first step towards harmonising tax rates – and could even lead to an EU wide corporate tax.

Harmonising tax rates or even an EU corporate tax are no necessary consequences of a first move on the harmonised tax base. They are even, politically speaking, unrealistic to expect. This political perspective is not only unfortunate, but is in fact a case against harmonising the tax base.

At first sight, especially from an EMU perspective, tax harmonisation should be welcomed: The Common Tax Base is expected to push cross-border business integration and encourage cross-border investment. Thus, the problems of insufficiently integrated markets in the EU could be alleviated. Furthermore, for companies operating in several EU countries, compliance costs would be considerably reduced, which could have an impact on competitiveness vis-à-vis the outside world.

But at the same time, harmonising the tax base without harmonising the tax rate would considerably increase tax competition due to the achievement of true transparency with regard to the tax burden. So, an instrument that is being sold as a mean against tax competition (linked to the famous “race to the bottom-argument” from mostly Western European countries) is actually one that would increase competition, if not accompanied by other means.

Furthermore, governments would loose an important instrument for fiscal stabilisation: Harmonising the tax base would mean that governments, can no longer use increased possibilities of temporarily more genorous depreciation allowances in an economic downturn in order to give companies an incentive to invest. Yet, temporarily more generous depreciation allowances are one of the most effective fiscal instruments to stimulate corporate investment and – as corporate investment is the GDP component most closely correlated with employment – job creation in the short run. This has been shown not only in the US where president George W. Bush used this instrument to boost growth in 2004, but also in Germany, where the newly elected grand coalition used this instrument successfully to boost investment in 2006 and 2007.

All this means that governments which decide to go the first step of harmonising the tax base, should from the start envisage to go steps two and three as well. Step two would be to introduce a harmonised tax rate – or even better, an EU coporate tax to add a stabilising effect to the EU budget, at a moment at which fiscal stabilisation on the national level would be even further restricted by the loss of temporary changes in the depreciation allowance. Step three would be to create the possibility for those countries participating in the harmonised tax base to jointly agree rules for admitting scope for corporate deductions in exceptional cyclical situations in order to increase corporate investment. This would prevent that the attempt to harmonise the tax base has secondary effects which stand in straight contradiction to the Lisbon Agenda’s goals. Neither the arguments for a common tax base, nor those for complementary steps will convince all EU countries, not even all EMU countries. Some, especially smaller ones and those which built their economic catch-up process on a tax system rather taxing consumption than corporate activities or income, will want to stick to full autonomy for reasons of sovereignty and of competition.

The EU should hence give up the ambition to have a harmonised tax base across all 27 EU countries immediately. It could and should rather opt for enhanced cooperation on that matter (as laid down in the EU Treaty with a minimum of eight member states adopting a common stance on this issue). The EMU member states (of course probably apart from Ireland) should assume leadership on this issue.

This post was co-published on .

One Response to "The downsides of harmonising the EU corporate tax base"

  1. interested reader   April 14, 2008 at 2:28 pm

    Thanks for this interesting article. It is still not entirely clear to me why it should not be possible to have a harmonized tax base with tax rate competition, including depreciation allowances? Is there a legal link preventing that? Why can’t that be changed? Thanks.