• What about direct tax harmonization in the EU?

    By Dr. Mihaela Göndör

    27-06-2016

    Introduction

    To summarize the EU initiatives on tax harmonization, only the VAT rates and the excise duties have achieved a high degree of harmonization with the establishment of the Single Market and the abolition of intra-Community tax controls, following the article 93 (99) EC Treaty and therefore help preventing double taxation, tax avoidance and disturbing of tax competition. In the field of customs duties, EU obtained the most successful level of tax harmonization. Customs duties have been abolished for the intra-Community trade, and in commercial relations with other countries, the Member States practice a common customs tariff.

    As it regards the income taxes, the reality reveals the large ranks of asymmetric tax rates that currently exist in the EU. Apart from the tax rates, tax legislation is a very important matter because it is in many cases rather complex and large differences from country to country rise problems to enterprises doing business abroad.

    Moreover, the literature on the subject of the harmonization of the income tax (corporate and personal) within EU is fueled by one central question: Is regulated tax harmonization or is market driven tax competition the best solution to the economic growth for the EU state members to take fully advantages of the common market? The existing viewpoints run the gamut from entirely pro-harmonization to pure pro-competition stances. As a whole however, the literature simply reveals the ambiguity of the issue, as reflected by its increasingly complex attempts to convey the reality of the European situation.

    The purpose of this article is to present the situation regarding the CIT (corporate income tax) and PIT (personal income tax) rates that currently exist in the EU, in order to have a base for a future discussion on the topic of tax harmonization vs. tax competition in EU.

    The facts

    The EU reality demonstrates a very large range of income tax rates among member states. The new Member States display lower top rates, while the highest rates are typical of Member States with the most elevated overall tax ratios, as seen in Table no. 1.

    Regarding the CIT, the difference between the lowest rate (10% in Bulgaria) and the highest rate (35% in Malta) is 25 pp., more even the average EU-28 (22, 8%), as seen in Table no. 1.

    Regarding the PIT, the difference between the lowest rate (10% in Bulgaria) and the highest rate (56, 5% in Portugal) is 46, 5 pp., much more even the average EU-28 (39, 3%) (Table no. 1).

    Moreover, the new Member States have a different structure of the fiscal system, compared with the old Member States. While most old Member States display a high share of revenues from direct taxes, indirect taxes, and social contributions, the new Member States often display a substantially lower share of direct taxes in the total. Several of these countries have adopted flat rate systems, which typically induce a stronger reduction in direct than indirect tax rates.

    There are differences not only between the old and the new Member States, but also among the old Member States, and among the new Member States, as seen in Table no.1.

    Table no. 1. Top statutory income tax rates within European Union, 2015 (%)

    Member State Corporate Income Tax CIT Personal Income Tax PIT
    Austria 25 50
    Belgium 34 53,80
    Bulgaria 10 10
    Cyprus 12,50 35
    Croatia 20 47,20
    Czech Republic 19 22
    Denmark 23,50 55,80
    Estonia 20 20
    Finland 20 51,60
    France 38 50,30
    Germany 30,20 47,50
    Greece 29 48
    Hungary 20,60 16
    Ireland 12,50 48
    Italy 31,40 48,90
    Latvia 15 23
    Lithuania 15 15
    Luxembourg 29,20 43,60
    Malta 35 35
    Netherlands 25 52
    Poland 19 32
    Portugal 29,50 56,50
    Romania 16 16
    Slovakia 22 25
    Slovenia 17 50
    Spain 28 46
    Sweden 22 57
    United Kingdom 20 45
    EU-28 22,80 39,30
    EA-19 24,60 42,10

    Made by author using data from http://ec.europa.eu.

    Discussions

    The question 1: What does it mean Tax Harmonization?

    1. Tax harmonization consists in coordinating the taxation systems of the European countries to avoid non-concerted and competing changes in national fiscal policies, which could have an adverse effect on the internal market.
    2. Total tax harmonization means the result of the structural harmonization and harmonization of the tax rates.
    3. The structural harmonization means the result of the harmonization of the structure of taxes (especially the tax rules and tax bases).

    Tax harmonization can also be understood as the process, the tools for reaching the selected aim and the result, harmonization of tax legislation itself together.

    Once the concepts defined and the asymmetric income tax rates presented, it becomes very clear that full tax harmonization covering 28 countries is a difficult undertaking, since this area remains largely the prerogative of the Member States.

    The question 2: Do we need a tax harmonization in EU?

    Yes, we need for at least four reasons:

    1. to stop the harmful tax competition.
    2. to reduce the tax evasion.
    3. to reduce the cost of tax compliance of companies doing business within EU
    4. to fully take advantage of the common market.

    The question 3: If the reasons exist, why is it so difficult to harmonize the income taxes in EU?

    I will try to systemize the answers as it fallows:

    1. The fiscal policy is one of the few macroeconomic tools that governments have at their disposal to influence the business cycle/economic growth (especially for the Eurozone member states).
    2. Taxation is a determinant for investments and particularly for FDI (foreign direct investment). Logically, investors will be attracted by the countries with low tax rates. Emerging economies have become more and more attractive to investors and FDI in these countries is increasing.
    3. Making the reality more complex that it should be according to the previous answer, the empirical evidence shows that most of FDI inflows are still oriented to the developed economies, despite their higher level of taxation, which means that higher tax rates create better business environment. A high CIT/PIT rate will stimulate the FDI inflows if the revenue is used to provide public goods that improve the environment in which investors operate.
    4. In the case of harmonization of the tax rate, which will be the common tax rate in EU? Will it be the actual average? It means 22,8% CIT rate, and 39,3% PIT rate. Is it a proper solution?
    5. From the perspective of Laffer theory (see graph no1), it exists a critical tax rate (t∙*) which rises to a maximum rate of revenue (Tmax), depending on the level of the economic development of the country. A tax increase (t3 > t∙*) or cut (t1 < t∙*) may reduce taxed activity and raise less revenue than otherwise predicted (T1 < Tmax), just as a tax cut (t3 < tmax) may increase taxed activity and raise more revenue than otherwise predicted, depending on the actual critical tax rate. Therefore, the critical tax rate differs from country to country. We can conclude that there are 28 critical different tax rates (t∙*) in EU.

    What will happen in the case of harmonization by adopting the actual average tax rate?

    The countries with lower tax rates will lose revenues by moving in the right part of the t∙* (Bulgaria, Cyprus, Czech Republic, Ireland, Latvia, Lithuania, Poland, Romania, Slovenia) and the countries with higher tax rates will lose revenue by moving in the left side of the t∙* (Belgium, France, Germany, Italy, Portugal, Malta, Spain). Therefore, the above solution is not a proper one. (Of course, the shape of the curve is a simplified one.).

    Graph.no.1 The Laffer Curve

    Graph.no.1 The Laffer Curve

    Conclusion

    1. Tax harmonization is an almost impossible goal for European Union.
    2. So many national different tax regulations pose problems for all companies doing business abroad.
    3. The solution could be the harmonization of the tax basis (the structural harmonization).

    This article rely on my last year's research on the topic “Discretionary and Nondiscretionary Fiscal Policy of the European Union Member States".

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Dr. Mihaela Göndör

Dr. Mihaela Göndör is an Associate Professor PhD at “Petru Maior” University of Tîrgu Mures, Romania. Her educational background includes Bachelor of Economics, Master Degree in Local Public Administration Management, PhD in Economics/Financial Management and a Postdoctoral degree in EU fiscal policies. Mihaela is consultant and Judicial Tax Expert, member of the Chamber of Tax Consultants, Romania. She is awarded with a postdoctoral scholarship from the Romanian Academy with the theme “Discretionary and Nondiscretionary Fiscal Policy of European Union Member States”. She is author and co-author of 10 books, 47 university courses, 29 professional research papers published in international journals indexed in international research bases, 70 publications in international conferences volumes and proceedings. She is in charge of the following academic courses: Public Finance, Public Budget, Comparative Taxes and Fiscal Policies, Financial Policies, International Finance. Her research interests are public finance, taxation, fiscal policy in EU.
She is regularly quoted in local and international research papers, scientific articles, books, and publications.

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