Strategies for Harnessing a Competitive EU Tax System
“There are two kinds of European nations. There are small nations and there are countries that have not yet realized they are small nations.” This comment by a former Danish Finance Minister stirred controversy in Britain amid the 2017 Brexit discussions. Despite the backlash, the essence of this remark seems to be resonating with European leaders today.
The recent shift toward the political right in the European Union, observed from June’s election outcomes, has brought “competitiveness” back into focus. During her introduction of the next EU commission, President Von der Leyen emphatically stated, “the whole college is committed to competitiveness!”
Competitiveness, however, can be interpreted in various ways. For some, it signifies government-led industrial strategies, while others view it as a propensity to transfer legislative power to corporate interests.
Regarding taxation, all EU Member States have avenues to enhance their tax system competitiveness by lowering marginal tax rates, refining capital cost recovery measures, and improving revenue collection efficacy. On a broader EU level, policies like completing the Capital Markets Union (CMU) and avoiding an international subsidy race can boost investment and long-term growth.
For a constructive dialogue on tax policy, shifting the competitiveness debate from politics to fundamental principles is imperative.
Urgency for a Competitive European Mindset
Calls for a competitive Europe are reverberating beyond governments. Recent reports from both the Draghi report and the International Monetary Fund (IMF) highlight worrying statistics about Europe’s competitive edge.
The Draghi report underscores that “due to a slowdown in productivity growth in Europe . . . real disposable income per capita has grown nearly twice as much in the United States compared to the EU since 2000.” The report stresses the increasing urgency for growth in Europe.
The IMF attributes Europe’s slower pace of business dynamism, relative to the US, partly to constraints on scaling up innovations. They propose “removing barriers to goods, services, capital, and labor flows within the single market” as a solution.
Both the Draghi report and IMF analysis draw heavy comparisons with the US, recognizing that increased competitiveness is essential for Europe to thrive geopolitically. French President Emmanuel Macron remarked that the EU has “2 or 3 years to stave off total US and Chinese market dominance.”
With this backdrop, it’s clear the EU must bolster its economic competitiveness, and the incoming commission has ambitious plans. But how does this translate in the realm of tax policy?
Defining a Competitive Tax System
In the public discourse, a competitive tax system often equates to a low corporate tax rate. Though the corporate rate influences investment decisions, true competitiveness extends beyond that.
According to Tax Foundation’s International Tax Competitiveness Index (ITCI), a competitive tax framework maintains low marginal tax rates, boosting the viability of investment projects, thus fostering a greater volume of initiatives, pivotal for sustainable growth given capital mobility.
High marginal tax rates can curtail domestic investment and spur tax avoidance practices. Importantly, competitive marginal rates should extend to personal income taxation to ensure incentives align with optimal taxpayer behavior and maximize government revenue.
The Role of Tax Neutrality
In addition to competitiveness, the ITCI underscores the value of a tax code that is neutral, seeks to maximize revenue with minimal economic distortion, and avoids double taxation. Simplifying the tax structure can thwart unintended incentives that lead to costly behavior modifications for tax advantages.
Raising government revenue efficiently is crucial. Consumption taxes, like the VATs across EU Member States, are less distortive compared to income taxes. While VATs may appear regressive, they provide a more stable revenue stream during economic fluctuations, enabling government support for those most in need.
A tax system truly “promotes sustainable economic growth and investment while raising sufficient revenue for government priorities,” as described in the ITCI.
Balancing Stability and Simplicity
Recent EU tax policies, such as implementing Pillar Two and temporary windfall profits taxes on oil and gas companies, contradict the principles of stability and simplicity. Policymakers should focus on streamlining the tax system to minimize compliance burdens and promote a stable business environment.
The reliance on temporary policies for short-term fiscal balance has led to distortions and tax uncertainty, hampering investment without generating expected revenue. The windfall profits taxes have diminished domestic investment in European energy sectors, sending mixed signals to pivotal investors.
Conclusion and Recommendations
Opportunities abound for EU Member States to refine their tax systems, optimizing competitiveness by pursuing less disruptive policies. As global dynamics evolve, European policymakers should prioritize reducing effective marginal tax rates to catalyze investment and growth.
Enhancing capital cost recovery processes, ensuring tax policy reliability, and avoiding inefficient subsidies will bolster Europe’s competitive stance. Beyond taxes, fortifying the CMU and expanding the Single Market to facilitate free movement of goods, services, capital, and labor are vital steps toward sustained investment and growth. Without these measures, Europe risks falling behind globally.
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