An effective corporation-tax system for the EU

Tax wars have so far denied the EU the unanimity required to stop the race to the bottom on corporation tax.

The European social contract is broken. The largest companies are no longer contributing adequately to the provision of the public services and infrastructure they use. If the European project and single market are to survive and thrive, there has to be an effective EU taxation system. The small amounts paid in tax by some of the most profitable companies in the world are undermining citizens’ belief in government, in politicians and in Europe.

The good news is that politicians are aware of these facts and are doing their best to construct a working tax system. Their best is however not yet good enough. 

The European Union has made feasible tax-reform proposals and the Organisation for Economic Co-operation and Development has developed corporate-tax reforms for the world, through its ‘base-erosion and profit-shifting’ process. Both are making progress but this is far too slow in terms of agreement among states. Europe needs fair taxation of companies now, when revenue is so urgently needed.

Political agreement

Corporate-tax reform will not be easy, as several challenges can be identified. But only two relate to the design of reforms: defining the base on which to tax companies and dealing with profit-shifting by multinationals (MNCs), particularly on intangibles. The others come down to securing political agreement. 

Taxation is a member-state competence and unanimity is currently required for EU action. Yet agreement is unlikely among all 27 member states because a few, such as Ireland, favour ‘tax competition’—in reality, tax wars—among democratic states to attract investment.

These tax wars have led to a fall in average nominal corporation-tax rates, from 35 per cent in 1995 to under 20 per cent today, and they are still falling. Even more importantly, effective tax rates are near zero for some top MNCs. 

Europe has a history of defending secrecy and ‘commercial confidentiality’ for companies, the rich, despots, criminals and money-launderers. The EU has also been the location for wars over other taxes—with states depressing income taxes, social charges and/or capital-gains taxes—which are not even being addressed, though all taxes are inter-related.

Iterative solution

The base on which corporation tax is calculated—what is taxed and what is deductible—would be contested in any state but especially in a union. The solution will be an iterative one after debate but certain issues need to be addressed. What is deemed tax-deductible was once quite simple but the tax wars by states, in competitive pursuit of foreign investment, have led to a great growth in tax breaks (on research, patents and so on) which has undermined the base. 

MNCs trade internally without market prices and can legitimately attribute prices. In a globalised economy this enables profit-shifting to low- or no-tax states, particularly for service and digital companies. It is difficult to police but co-operation among member states in the single market could contain it. 

It is not the rate of tax which is the issue but the actual tax paid. The EU should move from seeking ‘harmonised’ tax rates to co-ordinated rates within bands—say between 15 and 25 per cent. This would allow peripheral and poorer countries to set lower nominal rates if they wished. What is needed is to close gaps between nominal and effective rates and eliminate tax breaks.

A single market will not work effectively if one of 27 states can hold a veto on reform of the taxation of companies. The solution is some kind of majority or agreement by the outliers: Ireland, the Netherlands and Luxembourg.

The base, deductions, rates, intangibles and so on can be agreed by the experts, provided they are given permission to do so by political leaders in the member states. Progress on tax at the G20 in November should spur EU action.

Aggressive avoidance

Accounting is important in helping businesses to thrive. But by reducing tax revenue for vital public services, aggressive tax avoidance has turned ‘tax professionals’—among the highest-paid individuals in Europe, remunerated by the beneficiaries of low or no taxes—into value subtractors, taking from welfare rather than adding to it. 

Yet they determine the debate on taxation in many states, excessively influencing policy at many levels with their specialist knowledge, shrouding policy-makers with complexity. The Big Four accountancy and top legal firms also have their professional bodies and taxation institutes to influence opinion, not only via the media and universities but extending to top officials in governments’ finance departments.

The anti-tax lobby has however been too demanding, with corporate taxation reduced to almost zero. It has sparked a fierce reaction from the public which has changed the debate—finally inspiring action.

The EU is not moving quickly or effectively enough, though, in terms of openness and publication of country-by-country accounts. The black economy is almost 20 per cent of European gross domestic product.

Tax agency

Europe should establish a well-funded European tax agency, ‘Eurotax’, with wide powers of investigation into tax evasion and avoidance by wealthy individuals, companies and criminals. Eurotax would implement tax policy, including the co-ordination of tax assessments and collection. With a single market, the EU needs one tax body to oversee taxation in this globalised world. 

The agency would be staffed by experts seconded from each member state, to maximise expertise, co-ordination and co-operation. Eurotax could assist the tax authorities of deficient member states, showing them the latest methodologies in assessments and collection, ensuring no weak links within the union.

The EU must address the need for all 27 states to collaborate on all taxes over time to end tax wars. The process, difficult though it is, is mainly political and must be brought to a conclusion within two to three years.

This is part of a series on Corporate Taxation in a Globalised Era supported by the Hans Böckler Stiftung