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THE EUROPEAN UNION: A COORDINATED APPROACH TO TAXATION Christina Sigl Honors Thesis May 2012
2 The European Union: A Coordinated Approach to Taxation As tension from the Second World War subsided, European countries vowed to bargain and transact in a manner that respected the goals of the transacting countries. Economic coordin ation was possible with the establish ment of the European Union (EU) This 27 member organization works together to institute similar economic and financial goals. Each c ountry adopts and enacts similar economic policies coordinated by the Economic and Monetary Union. The goals of this framework are to increase employment and growth while improving t he welfare of all individuals. As Member States entered into a period of financial distress during 2008 and saw their economies stru ggle, they had different philosophies about how to rai se revenue and reduce spending. This recession has arguably affected the Greek economy more than any other EU member state. In 2009, the total debt to GDP ratio was 113.4 percent 1 No t only was Greece bankrupt, the ir economic status threatened the stability of the euro. In order to keep Greece function ing, the EU has had to develop bailout programs whose cost has been borne by the remaining countries. Frustrated with this proposal, Germany has recommended that the EU direct all Greek policies related to tax and spending 2 While this action was refused by the EU Commission, it has brought attention to the issues that will be discussed below. 1 2010. Slate http://www.slate.com/articles/news_and_politics/foreigners/2010/02/the_future_is_greek.html. (accessed February 12, 2012). 2 "Germans float direct EU control over Greek budget January 29, 2012. The Gainesville Sun, http://www.gainesville.com/article/20120129/WIRE/120129496/1003/NEWS?Title=Germans float direct EU control over Greek budget (accessed April 21, 2012).
3 Policy Setting EU policy closely aligns with the rule of law. All citizens must follow the law and the policies that have been set before them. These policies are created during a process known as the Ordinary Legislative Procedure. This procedure gives the European Parliament and the Council of the European Union the opportunity to discuss and generate a single policy. If the two parties are unable to reach a consensu s, additional discussions ens ue The outcomes of these discussions will dictate the conduct of the parties. Primary legislation set s the foundation for which policies may be enforced in particular regions. If a treaty has not been enacted in a country, they are not required to foll ow its provisions. Secondary legislation refers to regulations and decisions derived from primary legislation. 3 Effects of the Recession The interconnected European economies felt the impact of the economic and financial shock that devastated countries around the world in 2008. The International Monetary Fund conduc ted a survey early in 2009 studying the impact of the recession on European economies. Their conclusion that e mer ging and advanced countries suffered similar economic results was based on the fact that upply and demand for products. In order to stimulate the economies of these countries, it is crucial that the E U work together to establish a coordinated financial plan. In addition to increasing e conomic growth, 3 European Parliament http://www.europarl.europa.eu/aboutparliamen t/en/0080a6d3d8/Ordinary legislative procedure.html. (accessed February 10, 2012).
4 members. 4 The recession has affected these countries in different ways as some countries have seen their debt reach unprecedented heights while others are struggling to stabilize their real estate markets. Each member state develops and enacts their own fiscal budget that reflects their solutions to the economic issues they face. These solutions sha pe the tax reform po licies that have been adopted. Each country is given the opportunity to develop their own tax rate structure so long as it does not interfere with the overall goals of the EU. 5 In addition, Member States cannot impose a tax rate system that would interf ere with the transfer of goods and services between countries or restrict competition. Introduction to Corporate Income Tax Structures European Union tax policy has two main components: direct taxation and indirect taxation. Direct taxes are taxes on inco me and wealth for individuals and corporations whereas indirect taxes are imposed to encourage or discourage the movement of goods and performance of services. 6 Member States are afforded the opportunity to enact their own direct taxes so long as they respect the four freedoms explained in the EC Treaty: free movement of goods, persons, 4 Zoli, Edda "Europe Battles a Deep Recession May 12, 2009. International Monetary Fund, http://www.imf.org/external/pubs/ft/survey/so/2009/car051209a.htm. (accessed March 1, 2012). 5 European Commission http://ec.europa.eu/taxation_customs/taxation/gen_info/tax_policy/index_en.htm. (accessed February 10, 2012). 6 Summaries of EU legislation http://europa.eu/legislation_summaries/taxation/index_en.htm. (accessed February 10, 2012).
5 services, and capital. 7 Article 88 of the EC Treaty provides that indirect taxes a re largely dictated by the EU and must be harmonized because they hav e a high correlation to economic performance. 8 Member States have adopted flat tax rate systems, progressive tax rate systems, or some combination in order to satisfy their economic goals. A brief comparis on of these tax rate systems will help illustrate the freedom these countries have in deciding how to raise revenue. Flat Tax Rate System In 1994, Estonia became the first European country to adopt a flat tax rate system Estonia replaced their corporate income tax and personal income tax with a 26% tax. This uniform rate has simplified the tax calculation but has also been criticized for its lack of fairness. The following EU countries have also instituted a flat tax: Czech Republic, Hungary, Latvia, Lithuania, Romania, and Slovakia. 9 Progressive Tax Rate System Countries with a progressive tax rate structure are able to levy tax rates on individuals and corporations that relate to their ability to pay. Some count ries have instituted a progressive tax rate structure for individuals but believe that the most effective tax mechanism for corporations is a flat tax rate system. In response to the decline in economic growth, most Member States have lowered their corporate tax rate. 7 European Commission http://ec.europa.eu/internal_market/top_layer/index_en.htm. (accessed March 11, 2012). 8 Treaty European Commission http://ec.europa.eu/competition/legislation/treaties/ec/art88_en.html. (accessed March 11, 2012). 9 The Economist http://www.economist.com/node/3860731. (accessed February 10, 2012).
6 Competition in the European Union The Commission interviewed independent experts in a 1990 study to determine what impact varying corporate tax rates had on investment decisions. Other factors being equal, business es prefer to conduct operations in countries that have lower, more favorable tax rates. T hese expert s suggested that the tax rates, assessment basis, and collection procedures be harmonized among the Member States to reduce the tax discrepancies. 10 Th e Co uncil recognized the importance of coordinated policy setting at the European Union level and adopted a code of conduct duri n g a 1997 Ecofin Council meeting. While this initiative is not legally binding, it has had a positive impa ct in reducing harmful ta x competition. Among its initiatives, the code of conduct would prevent Member States from introducing any harmful tax measures (standstill) and would roll back already implemented harmful tax measures. 11 Member States are encouraged to avoid competing amongst themselves for the lowest income tax rate system. The example that follows helps illustrate the effects harmful tax policies can have on nondomestic business. The questionable tax policies that have been imple mented in Hungary have led many EU countries to consider a harmonized tax system. Faced with an enormous budget deficit, Hungary has instituted numerous new taxes that would help raise reven ue. Among these measures, the telecommunication, energy distribu tion, and retail industries The majority of these businesses are foreign owned and have very little incentive to contin ue operating in these countries. This tax policy, as well as some of the other directives 10 Tax Policy in the European Union (European Communities, 2000) http://ec.europa.eu/publications/booklets/move/17/txt_en.pdf (accessed February 16, 2012), 3 38. 11 European Commission http://ec.europa.eu/ta xation_customs/taxation/company_tax/harmful_tax_practices/index_en.htm. (accessed February 16, 2012).
7 carried out in Hungary, has alarmed global companies as they see the freedom these countries have in setting their tax policies as a potential threat to foreign operations. 12 While Switzerland is not a member of the EU, they have been heavily criticized f or their low tax rates. The EU Commission cites specific instances where they have failed to comply with the code of conduct due to their harmful tax practices. Cantonal governments set income tax policies that have been significantly lower because they look to satisfy their constituents. While these policies are legal, the EU has demanded Switzerland to comply with their policies. The EU believes lower corporate tax rates are a subsidy and if not corrected, could threaten uct operations with EU countries. 13 Romania The Romania economic environment has suffered through a period of political interference that has created a corrupt and unstable economy. In order to balance out this decline in growth, the Romanian government r educed the flat tax rate to 16% and has continued to tax profits earned by corporation s and the distributions received by individual shareholder s Corporations are exempt from paying tax on dividends they receive from other resident companies. The EC Par ent Subsidiary Directive requires that companies withhold and remit 16% of the interest, dividends, and royalties if they are non residents registered in an EU member state. 14 12 EurActiv, http://www.euractiv.com/enterprise jobs/eu firms nervous about new hungarian laws taxes news 500891. (accessed March 3, 2012). 13 The New American, http://thenewamerican.com/world mainmenu 26/europe mainmenu 35/9953 eu threatens tiny switzerland over low taxes. ( accessed March 20, 2012). 14 Romania European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/ro.pdf. (accessed April 2, 2012).
8 Ma lta Malta saw its economy grow at a rate of 3.4% during the first quarter of 2010. This rate has dec lined as Malta has struggled during the recession. Malta has adopted a policy of gradual liberalization whereby policy regimes dictate the strategies they follow. These policies have allowed Malta to collect the largest corporate income tax revenues as a percentage of GDP. Tax revenues are large because the corporate tax base has widened and Malta has increased their efficiency in collecting income taxes. E conomic goals have also led the Maltese government to introduce tax incentives for small and medium sized companies. 15 Cyprus The economic policies institu ted by the Cyprus government encourage business and employment. With no minimum capital requirement and a maximum corporate tax rate of 10%, corporations have an incentive to open and continue conduct ing business in Cyprus Cyprus maintains its economic freedom through its transparent and efficient policy setting. Th ese policies tend to favor private sector growth and development. The recession has also influenced the tax cuts that were implemented to increase revenue. The shipping industry has seen important changes to their tax system. Carry back losses are not allowed but companies can carry forward losses indefinitely. 16 15 European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/mt.pdf. (accessed April 2, 2012). 16 Cyprus European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/cy.pdf (accessed April 2, 2012).
9 Luxembourg Even though the highest corporate income tax rate is only 22%, the tax revenues generated are among the highest in the EU. In addition to the corporate income tax, corporate inc ome is subject to a surcharge for an employment fund and a municipal business tax. L uxembourg has a relatively stable economy and business owners have enjoyed this favorable environment. As economic growth slowed, it became more important for Luxembourg to collect the tax revenues that were calculated by corporations. In 2010, Luxembourg implemented a self assessment system whereby taxing authorities evaluated the likelihood of error and imposed corrective action for mistakes. 17 Additional tax credits w ere enacted to encourage sustainability and encourage energy saving. 18 Czech Republic The Czech Republic has experienced a period of rapid industrialization. The current economic policies The corporate income tax is paid by corporations, limited liability companies, and limited partnerships. These entities pay tax on corporate income at a flat rate of 19%. Int erest, dividends, and royalties for residents and non residents are subject to a withholding tax of 15%. Parent corporations that are registered as an EU member state are exempt from paying the withholding tax on dividends and capital gains. 19 17 The Heritage Foundation, http://www.heritage.org/in dex/country/luxembourg (accessed April 2, 2012). 18 European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/lu.pdf. (accessed April 2, 201 2). 19 Czech Republic European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/cs.pdf (accessed April 2, 2012).
10 Greece Th e demoralizing statistics that characterize the Greek economy are the accumulation of years of overspending and political turbulence. Corporations that reside in Greece are taxed on their worldwide income and capital gains. The progressive tax rate syste m in place imposes a maximum 25% tax rate in 2010 which is reduced by 1% each year until 2014. In addition to this income tax, corporations are also subject to a real estate tax. Corporations are not able to carry back losses but may carry forward losses up to five years. 20 Understanding the Greek economic system is dif ficult because tax evasion is commonplace. Greece has not been able to enforce the law and citizens and businesses a like have taken advantage of this lack of control. The gap between what taxpayers owed and what they paid in 2010 represented one th ird of the total tax revenue. In addition to these lost revenues, Greece has incurred expenses in trying to tighten their tax collection procedures. A regressive tax system has resulted as the rich are more likely to evade paying taxes. In addition to weak laws, Greece has experienced difficulties in collecting outstanding taxes. Greece tax officials have been known to accept small envelopes of cash as payment of taxes. Collectors have also struggled to collect taxes because the tax court takes, on average, seven to ten years to resolve cases. 21 20 Europe an Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_struct ures/2011/country/el.pdf (accessed April 2, 2012). 21 Surowiecki, James "Dodger Mania July 11, 2011. The New Yorker, http://www.newyorker.com/talk/financial/2011/07/11/110711ta_talk_surowiecki. (accessed April 21, 2012).
11 Hungary The economic crisis has also been felt in Hungary as they became the first EU member state to receive financial assistance from the EU I MF bailout program. Corporations are subject to a flat tax of 19% on taxable income and no longer have to pay tax on the 4% solidarity tax. Capital gains are taxed at ordinary tax rates and dividends paid by controlled foreign corporations are not deductible by the Hungarian corporation. 22 Impact on Member States There are numerous tax and nontax considerations that entities consider when deciding where to conduct business. Other factors equal, a corporation would prefer to pay tax at a lower corpo rate tax rate. The alternatives presented below highlight the issues currently facing the EU. Countries, such as Germany, that are financing the bailout programs want the EU to set a harmonized tax rate that would prohibit countries from gaining a compet itive advantage. Other countries that have particularly low tax rates want to continue setting their own rates as they see this as an equitable, fair approach to raising revenue. Common Consolidated Corporate Tax Base (CCCTB) and Other Alternatives While the 27 Member States and EU as a whole have recognized the importance of reforming current tax policy, they have yet to determine an appropriate measure that woul d benefit all countries alike. One recommendation that has been considered is the implementation of a Common Consolidated Corporate Tax Base (CCCTB). Companies conducting business across any of the 27 Member States would determine their taxable income according to a single 22 European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_st ruct ures/2011/country/hu.pdf. (accessed April 2, 2012).
12 set of rules Groups using this CCCTB would be able to file one consolidated tax return for operations throughout the EU. The consolidated income presented on this return would be apportioned among the Member States according to factors such as sales, employment, pa yroll, and assets. The ap portioned income would be subject to tax in each country according to a tax rate sele cted by the individual country Research gathered by Leon Bettendorf, Senior Economist with the CPB Netherlands Bureau for Economic Policy Analy sis, explains that the impact of this policy would not affect the EU as a whole. In addition, a harmonized tax rate system would minimize the need for tax planning which would lower employment. 23 Reducing employment and growth would counteract the benefits of consolidation and additional solutions have been explored. The 2012 Annual Growth Survey was presented on November 23, 2011 in Brussels This presentation provides solutions to many of th e issues discussed in the Euro Plus Pact of 2011. These issues addressed the need to exchange best practices and eliminate tax evasion, among other s. While coordination among the EU countries was at the forefront of these discussions they did not try to develop a common tax base system. Instead, the c ouncil members are urging the Member States and EU to establish a n open communication l ine 24 An open communication line would benefit all Member States as they try to accomplish similar economic goals. Efficiency would improve as guidance and information are shared across countries. Coordination would also benefit entities conducting operations across borders because it would help standardize tax repor ting. 24 23 VoxEU, http://www.voxeu.org/index.php?q=node/6248 (accessed March 2 2012). 24 Growth friendly tax policies in member states and better tax coordination in the eu http://ec.europa.eu/europe2020/pdf/ags2012_annex4_en.pdf.
13 Regressive tax rate systems have emerged in Greece and Romania as rich citizens have engaged in f raud and tax ev asion Coordinated efforts must be m ade by each country to eliminate these harmful tax practices and encourage growth. While these issues are not wide spread, the council would like to address countr y specific issues and have them addressed by all of the Member States Advantages of these coordinated efforts include: creating a level playing field for individuals and businesses, limi ting and preventing abuse, and preventing harmful tax consequences. 24 Additional directives published by the council include a Common System of Financial Transaction tax, an Energy Taxation Directive, a Savings Directive, and a VAT Directive. These propos als have not been addressed because they are in the early stages of discussion. 24 Conclusion The recession has had devastating effects on the 27 Member States as they have seen very little growth in economic activity. In order to remain a competitive force, some countries have reduced their income tax rates for corporations. These income tax systems not only affect the entities that are conducting business, but they also affect the financial environment of the host country. While it is di fficult to quantify the impact a harmonized tax rate would have on the EU as a whole, I believe it is a viable option that should be considered. If a harmonized tax rate were imposed on Member States it would be beneficial to have an effective means for these countries to bring emerging issues before the EU Commission This open discussion would allow each country to voice their opinion on prospective changes.
14 Bibliography The Heritage Foundation, http:// www.heritage.org/index/country/cyprus (accessed April 2, 2012). The Heritage Foundation, http:// www.heritage.org/index/country/luxembourg (accessed April 2, 2012). Europa http://europa.eu/pol/tax/index_en.htm (accessed February 18, 2012 ). Applebaum, Anne. February 16, 2010. Slate, http://www.slate.com/articles/news_and_politics/foreigners/2010/02/the_future_is_greek. html. ( a ccessed February 12, 2012 ) European Commission http://ec.europa.eu/competition/legislation/treaties/ec/art88_en.html (accessed March 11, 2012 ). Bettendorf, L. M. Devereux, S. Loretz, and A Corporate Tax Reform in the EU: March 20, 2011. VoxEU http://www.voxeu.org/index.php?q=node/6248 (accessed March 2, 2012). European Commission http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_en. htm (accessed February 17, 2012 ). Cyprus European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/cy.pdf (accessed April 2, 2012). European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/cs.pdf (accessed April 2, 2012). European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/el.pdf (accessed April 2, 2012).
15 European Commission, http://ec.europa.eu/taxation_customs/resources/do cuments/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/hu.pdf (accessed April 2, 2012). European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/lu.pdf (accessed April 2, 2012). European Commission, http://ec.europa.eu/taxation_customs/resources/docu ments/taxation/gen_info/economic_a nalysis/tax_structures/2011/country/mt.pdf (accessed April 2, 2012). European Commission, http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_a nalysis/tax_str uctures/2011/country/ro.pdf (accessed April 2, 2012). European Union http://europa.eu/pol/emu/index_en.htm (accessed February 19, 2012 ). EurActiv, http://www.euractiv.com/enterprise jobs/eu firms nervous about new hungarian laws taxes news 500891 (accessed March 3, 2012). European Commission http://ec.europa.eu/taxation_customs/taxation/gen_info/tax_policy/index_en.htm (accessed February 10, 2012 ) European Commission http://ec.europa.eu/internal_market/top_layer/index_en.htm (accessed March 11, 2012 ). Germans float direct EU control over Greek budget ." January 29, 2012 The Gainesville Sun, http://www.gainesville.com/article/20120129/WIRE/120129496/1003/NEWS?Title=Ger mans float direct EU control over Greek budget (a ccessed April 21 2012 ) Growth friendly tax policies in member states and better tax coordination in th e eu (2011). Retrieved from http://ec.europa.eu/europe2020/pdf/ags2012_annex4_en.pdf European Commission http://ec.europa.eu/taxation_customs/taxation/company_tax/harmful_tax_practices/index _en.htm (accessed February 16, 2012 ).
16 The New American, http://thenewamerican.com/world mainmenu 26/europe mainmenu 35/9953 eu threatens tiny switzerland over low taxes (accessed March 20, 2012). European Parliament http://www.europarl.europa.eu/aboutparliament/en/0080a6d3d8/Ordinary legislative procedure.html (accessed February 10, 2012 ). European Commission http://ec.europa.eu/taxation_customs/ taxation/company_tax/gen_overview/index_en.htm (accessed February 10, 2012 ). Surowiecki, James Dodger Mania ." July 11, 2011 The New Yorker, http://www.newyorker.com/talk/financial/2011/07/11/110711ta_talk_surowiecki (a ccessed April 21 2012 ) Summaries of EU legislation http://europa.eu/legislation_summaries/taxation/index_en.htm (accessed February 10, 2012 ). Taxation and the EU ." April 12, 2012 Civitas, http://www.civitas.org.uk/eufacts/FSECON/EC3.htm (a ccessed April 21 2012 ) European Commission http://ec.europa.eu/taxation_customs/taxation/gen_info/economic_analysis/tax_structures /index_en.htm (accessed February 16, 2012 ). Tax Policy in the European Union European Communit ies 2000. http://ec.europa.eu/publications/booklets/move/17/txt_en.pdf (accessed February 16, 2012). April 14, 2005. The Economist http://www.economist.com/node/3860731 (accessed February 10, 2012 ). Official Journal of the European Communities. http://ec.europa.eu/taxation_customs/resources/documents/coc_en.pdf (accessed March 2, 2012).
17 Zoli, Edda Europe Battles a Deep Recession ." May 12, 2009 International Monetary Fund, http://www.imf.org/external/pubs/ft/survey/so/2009/car051209a.htm (a ccessed March 1 2012 )