How the EU is fuelling tax competition
by David Walch
Tax fraud and tax dumping are a key factor in rising inequality. As the tax revenue from multinational corporations and wealthy individuals falls, the majority pays the price – in the form of higher taxes or worsened public services.
The race to the bottom in corporate taxes is a global problem. What is remarkable, however, is the way the EU has fanned the flames internally: the average corporate tax rate in the EU fell from 49 to 24 percent between 1980 and 2014, a greater decrease than in other industrialised nations. The top income tax rate has followed this downward trend. Despite an increasing concentration of wealth, many EU countries have abolished or reduced their taxes on wealth. A pronounced downward spiral has also been seen in the tax rates for capital income, which – unlike wage income – is increasingly less progressively taxed.
Yet the downward spiral in nominal tax rates is only part of the problem. The tax rate from mobile capital continues to decline due to the shift of profits and wealth to low-tax countries and tax havens. Profit shifting by multinational corporations – much of which takes place legally – has led to worldwide tax losses of approximately 500 billion dollars, while up to 32 trillion dollars of private wealth is parked in tax havens around the world.
Tax policy in the EU
Within the EU, tax policies can only be implemented on the basis of unanimous decisions by all member states. Though the EU Parliament is consulted, it has no right of co-decision. In addition, according to the EU Treaties, tax harmonisation is generally only permissible for the purpose of ensuring the “functioning of the single market” or preventing “distortion of competition”.
When it comes to indirect taxes – that is, mass taxes such as value added taxes (VAT) or consumption taxes – harmonisation measures are laid out in the EU Treaties to prevent them acting as “obstacles to the internal market”. These measures have been implemented consistently since the 1960s and are constantly undergoing further development; VAT, for example, is subject to a European minimum rate of 15 per cent.
In contrast, no degree of harmonisation is explicitly stipulated in the Treaties in regard to direct taxes (income, wealth or corporate taxation). Because of this, harmonisation measures have been implemented only occasionally or without obligation. Discussion regarding the harmonisation of corporate tax rates persisted until the 1990s, without fruitful results. Since that time, the Commission has generally viewed tax competition in a positive light as a result of its perceived ability to reinforce the “budgetary discipline of individual states”. Isolated attempts at progress, including as a result of eastward expansion, were unsuccessful on account of the protests of low-tax countries.
In regard to wealth and capital income taxes, too, any harmonisation of tax rates or introduction of minimum rates appears to be as much of a political non-starter as the additional option of restricting the free movement of capital to non-European countries.
Although tax policy is formally a matter of national competence, the freedom of EU-member states to determine this policy is severely limited. The Maastricht Treaty permits restrictions on market freedoms only in exceptional circumstances. However, since the ECJ does not classify tax revenue as an “overriding requirement of public interest” (!), states are not able to make use of existing safeguard clauses to protect themselves unilaterally against tax dumping. While it is true that the so-called “sweetheart deals” between member states and multinationals – which included tax rates of less than one percent and were made public by the LuxLeaks-scandal – were judged by the Competition Commission as “illegal state aid”, this does not paint the whole picture. The fact that Ireland and Luxembourg were refusing to charge corporations for billions of euros’ worth of back tax payments shows how deeply corporate interests have embedded themselves in the “business models” of certain EU member states.
Equally problematic is the fact that EU countries can fuel tax competition at a unilateral level, but have barely any ability to defend themselves against it at the European level, since this would require unanimous agreement. At a national level, this favours both corporate groups and interest groups demanding tax cuts for the rich. Ultimately, the question is usually only about how to respond to existing tax competition, not whether it is desirable in the first place. As a result, states have formal tax autonomy, but are nevertheless caught up in the tax race to the bottom of the “free” single market.
The European fight against tax fraud and tax avoidance
The financial and economic crisis and tax scandals such as LuxLeaks or PanamaPapers have put “illegal” tax fraud and “legal” tax avoidance on the international political agenda after many years of falling through the cracks.
The most comprehensive attempts to prevent tax dodging at the EU level exist in respect of natural persons. Back in 2005, the European Savings Tax Directive agreed on the automatic exchange of information regarding taxation of savings income in the form of interest payments in the EU, albeit with major loopholes and gaps. One such loophole is that the Directive did not apply to third countries, while Belgium, Austria and Luxembourg insisted on retaining their banking secrecy. The initial drive for tightening the regulations was provided by the USA’s attempts to crack Swiss banking secrecy and obtain information from the accounts of US citizens abroad. As of 2014, and based on the political objectives of the G20, the OECD has been working on developing a comprehensive standard for the automatic exchange of information between tax authorities (AIE). This is now also being implemented in the EU. Although this standard represents an important paradigm shift, it still leaves numerous loopholes open for tax dodgers and places developing countries at a particular disadvantage.
Furthermore, so long as wealth can be hidden anonymously in trusts, shell companies or other non-transparent structures, the automatic exchange of information alone is not enough. To counter this issue, the EU’s fourth directive on money laundering requires the implementation of mandatory registers of the beneficial owners of such structures operating in the EU. These registers will be open to the public or to persons with “legitimate interest” by 2020. The AIE also stipulates the exchange of detailed annual reports by corporations on their economic activities, profits and tax information in each country (“country by country reporting”); however, only about 5 per cent of companies (those reporting over 750 million euros’ turnover) are required to comply with this requirement. A better method would be to make these reports publicly accessible in the interests of transparency and public scrutiny, as is already the case in the EU for banks and commodity companies. Although the European Parliament and the EU Commission are in favour of this, countries such as Germany and Austria still oppose it.
But the international taxation of corporations suffers from a fundamental design flaw. When it comes to taxation, national subsidiaries of multinational corporations are treated as if they were completely separate entities, which in turn allows them to shift their profits to branches in low-tax countries. These include EU-tax havens as Ireland, Luxembourg or Malta. The profits reported in the actual location of value creation – where higher taxes are incurred – are much lower. The current approaches of the OECD and the G20 (which are also implemented in the EU) attempt to stem this tax fraud by means of complex technical solutions, but do not attempt to fundamentally fix the system.
One potential fix for this issue would be the introduction of “unitary taxation”. Within this approach, multinational corporations are treated as a single entity (that is, with one global profit figure) rather than as loose collections of separate entities trading with each other. Using a formula based on genuine economic factors like sales, payroll or physical assets, this global profit is then allocated to the countries in which the corporation does business and taxed accordingly. This approach would put an end to profit shifting to tax havens.
Interestingly enough, since 2001, the EU Commission has been proposing a kind of EU-level “unitary taxation” called the “Common Consolidated Corporate Tax Base” (CCCTB). Due to fierce political resistance from member states, current plans are restricted to the harmonisation of tax bases and the offsetting of losses. The all-important issue of the allocation and taxation of profits is to be decided at a “later date” – in other words, maybe never. The biggest danger, however, is that the CCCTB will be implemented without minimum tax rates, since these are not yet even under discussion. If this happened, it would further displace tax competition to the nominal tax rate and continue to fuel the race to the bottom.
Rattling the neoliberal foundations
There is no doubt that more international cooperation is needed to combat tax fraud and tax avoidance – and it is certainly the case that some promising initial steps are being discussed or taken at the European level after decades of inaction.
However, replacing the principle for unanimity in the EU with majority voting not only appears somewhat utopian, but would also be problematic due to the democratic deficit of the EU Council – after all, tax issues also include the question of distribution amongst the EU States. What’s more, there are legitimate reasons to defend historically grown tax systems, and unifying 27 systems would be anything but straightforward.
The necessary fiscal harmonisation is not only being blocked by traditional profiteers such as Ireland or Luxembourg. Rather, it is the case that even large countries are unwilling to make strong, effective counter-offers, or are blocking moves for change themselves. The underlying issue is that lines of conflict are not only determined by “national egoisms”, but also by the same national capital interests that benefit from the competitive discourse. For evidence, one need only look at the endless debate surrounding the introduction of the European Financial Transaction Tax. It is therefore urgently necessary to clarify these lines of conflict precisely at the EU level.
Last but not least, the distinction between “unfair” and “fair” tax competition – an ongoing dominant area of focus at the EU level – completely ignores issues of distribution. However, there is no scope for a European tax-debate on distribution of wealth in either the current institutional framework (unanimity) or the current mainstream of the EU. For this, the EU would not only need to be democratised, but would also need to scrutinise its “self-imposed constraint” of the free movement of capital – in other words, to shake the very neoliberal foundations on which it is built.