Recommendations for a more competitive EU tax system
There are two types of European nations. There are small nations and there are countries that have not yet realized they are small nations.”
This quote by a former Danish Finance Minister drew British ire in the middle of the 2017 Brexit negotiations. However, the underlying message may be starting to enter the minds of European leaders.
Since the European Union’s election results in June revealed a shift to the political right, “competitiveness” has quickly reemerged as a key buzzword. In President von der Leyen’s recent speech introducing the next college of commissioners, she went as far as to claim that “the whole college is committed to competitiveness!”
However, competitiveness has different meanings. For some, competitiveness is the Trojan horse for government-led industrial policy, while others simply think it represents a government willing to outsource legislative power to corporate lobbyists.
When it comes to taxation, all Member States have opportunities to increase the competitiveness of their
taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
Cost recovery is the ability for businesses to recover the costs of their investment. It can impact investment decisions and help define a business’s tax base. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker‘s productivity and wages. policies, and raising revenue more efficiently. At the EU level, there are policies, such as completing the Capital Markets Union (CMU) and avoiding an international subsidy race, that can accelerate investment and long-term growth.To find actionable common ground on tax policy, the debate over competitiveness should move from politics to principles.Calls for a Mindset ChangeThe calls for a more competitive Europe are also coming from beyond the newly elected government. In the last month, both the Draghi report and the International Monetary Fund (IMF) have published alarming statistics on the state of European competitiveness.
For example, the Draghi report highlights the fact that “due to slowdown in productivity growth in Europe . . . Since 2000, the real disposable income in the United States has increased almost twice as much as it has in the EU. The report notes that the slowing growth was viewed as an inconvenience, but not as a catastrophe. . . It is not surprising that both Draghi’s and the IMF’s analyses compare Europe with the United States. Both pieces acknowledge that the geopolitical environment is changing and that becoming more competitive is key to Europe’s future. French President Emmanuel Macron even posited that the EU only has “2 or 3 years to stave off total US and Chinese market dominance.”
The EU needs to become more economically competitive, and the incoming commission has ambitious plans. What does it mean for tax policy in practice?
What is a Competitive Tax System
In European public debates, a competitive system is often misunderstood to mean a low rate of corporate tax. A competitive tax system is more than just a low corporate tax rate. According to Tax Foundation’s International Tax Competitiveness Index, a competitive tax code helps keep marginal tax rates low. This can increase the number of projects that are undertaken. This is especially important because capital, compared to labor or land, is highly mobile. This is especially important because capital, relative to labor or land, is highly mobile.
Conversely, high marginal tax rates not only lead to reduced domestic investment but can also lead to an increase in tax avoidance and planning behavior.[but]However, it’s not only about corporations. It is important to have competitive marginal rates for personal income taxation. Why Is Neutrality So Important?
In conjunction with competitiveness, ITCI recognizes the importance a neutral tax code which aims to raise as much revenue as possible while minimizing economic distortions. This means avoiding double taxation. Double taxation occurs when the same dollar of income is taxed twice, whether it’s corporate income or individual income.
In general, complexity is the enemy of neutrality because it tends to create unintended incentives in the tax code that encourage groups of individuals or firms to make costly changes in their behavior to gain tax advantages. In general, complexity is the enemy of neutrality because it tends to create unintended incentives in the tax code that encourage groups of individuals or firms to make costly changes to their behavior to gain tax advantages.
In this vein, efficiently raising government revenue is key. Consumption taxes are less distorting (more neutral) compared to income taxes for individuals or firms. This is because they are similar to the value-added tax (VAT) in all EU member states. VATs are a stable source of revenue, even though they can be regressive. This allows governments to maintain important resources in vulnerable times and decide how to target spending to those most in need to achieve their desired level of progressivity for the overall system.
In general, a competitive and neutral tax system “promotes sustainable economic growth and investment while raising sufficient revenue for government priorities,” as the ITCI puts it.
What About Stability and Simplicity?
The EU has recently pursued tax policies, such as the implementation of Pillar Two and temporary windfall profits taxes on oil and gas companies, that go against the principles of stability and simplicity.
Pillar Two has significantly increased complexity and is not expected to yield a significant amount of government revenue relative to fiscal needs. It has also accelerated tax competition through inefficient government subsidies which undermine the integrity and effectiveness of the Single Market, rather than low marginal tax rates. Policymakers would be wise to consider opportunities to “declutter” the system to reduce compliance and enforcement costs for companies and tax authorities alike.
Temporary policies used to plug short-term budget holes are distortive, create tax uncertainty that can lead to reduced investment, and therefore don’t usually generate the expected amount of government revenue. The temporary windfall profits taxes have not only failed to generate significant government revenue, but they have also reduced domestic European investment in energy and sent the wrong signal to important investors.
Recommendations
Broadly speaking, there are many opportunities for EU Member States to improve the competitiveness of their tax systems by raising revenue more efficiently through less distortive policies.
As the geopolitical scene continues to change, policymakers in Europe should focus on lowering effective marginal tax rates to drive much-needed investment and long-term economic growth. Improving capital cost recovery policies (by extending loss carryforwards and capital allowances), increasing tax certainty through sound and reliable tax policy, and avoiding the temptation to enter an inefficient subsidy race will give Europe a chance to compete.
Beyond tax policy, a well-functioning CMU and a deepening of the Single Market that removes barriers to the flow of goods, services, capital, and labor are essential. The top priority for leaders should be to increase European investment in order to drive long-term growth. If Europe does not take action, it risks falling behind its geopolitical rivals. Stay informed on the tax policies impacting you.Subscribe to get insights from our trusted experts delivered straight to your inbox.
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