Sijbren Cnossen

Tax Policy in the European Union: A Review of Issues and Options

As economic integration within the European Union (EU) progresses, the interactions between the tax systems of the Member States are of growing importance. Member State tax policies can have spillover effects on other Member States and differing abilities to provide net fiscal benefits to residents may impair the efficient allocation of productive factors across the EU. These considerations have important implications for the design and coordination of tax systems in the EU. Following a survey of tax developments and a review of the criteria that should govern the tax relationships between the Member States, this paper analyzes the issues and options that Member States face when levying and coordinating their taxes on consumption, labor and capital.

Global Trends and Issues in Value Added Taxation

Since the late 1960s, the VAT has become one of the mainstays of the tax systems in over one hundred countries. Apparently, its revenue raising and neutrality properties make it an attractive tax in a rapidly integrating, high-tax world. Following an overview of VATs throughout the world, this article examines various VAT structure and policy issues under the following headings: tax coverage features, tax base aspects, hard-to-tax sectors, rate structure issues, and interjurisdictional coordination problems. It is shown that the normative requirements of a ‘good’ VAT are often met only in the breach.

Coordination of value-added taxes

‘Parking place Europe’, read the headline of an editorial in NRC-Handelsblad, a Dutch newspaper, on February 23, 1984 when more than two thousand trucks were stranded in the Alps because of striking French truckers and Italian customs officers. Although the European Community (EC) has been tariff-free since 1968, there are still customs posts at nearly every inter-Member State border, regularly causing queues of lorries and automobiles even when there is no strike. The principal revenue job of customs personnel at internal border crossings is to process value-added tax payments and rebates on goods traded inside the EC. In addition, officers are involved in the control and collection of excises on tobacco, alcohol and petroleum products, the imposition of monetary compensatory levies on farm trade, the verification of customs documents, and the search for drugs. The costs of internal customs, including administration and delays, has been put at some 5–7 percent of the value of goods traded inside the Community every year.

How Much Tax Coordination in the European Union

This paper examines the trade-offs between tax autonomy and fiscal neutrality that the Member States of the European Union face in coordinating their taxes on consumption, labor and capital. One of the main messages is that in many cases tax reform should precede tax harmonization, mainly because the costs of distortions within Member States may be greater than the gains from reducing intergovernmental tax competition.

Europe`s new border taxes

Instead of abolishing internal border controls in 1993, the European Union (EU) replaced them with VAT and statistical requirements that appear to be just as onerous. For Dutch businesses, the compliance costs of the new requirements are, on average, 5 per cent of the value of their intra-EU trade. The figure is probably higher for other EU Member States. Obviously, the costs constitute a (differentiated) border tax that impedes intra-EU trade. The article analyses the determinants of the compliance costs, as well as their effect on intra-EU trade intensity. The article submits that the differential compliance costs violate the non-discrimination provisions of the EC Treaty. Suggestions are made to reduce them.

Tobacco Taxation in the European Union

Later this year, the European Commission has to submit a report to the Council of Ministers and the European Parliament with its views on tobacco tax policy in the EU. A 2004 publication issued by the Commission expressed the beliefs that tobacco consumption should be controlled by increasing tobacco excises and that harmonization should proceed on the basis of specific rates. This article reviews and evaluates EU tobacco tax policies. It supports the move towards specific taxation, but notes that there are conceptual and empirical limits to excessively high tobacco taxes. Smokers appear to pay their way and cigarette smuggling is a growing menace to health and revenue objectives.

Key Questions in Considering a Value-Added Tax for Central and Eastern European Countries

In the course of introducing a market-oriented tax system, most Central and Eastern European countries are actively considering the merits of a value-added tax. Social, economic, and technical issues pertinent to the introduction and operation of the VAT are examined, including the burden distribution of the VAT, its effect on price level and economic growth, as well as coverage, definition of the base, and choice of rate structure. Various legal and administrative aspects are also reviewed. The paper draws on the experience of EC member states and other OECD countries with value-added taxes.

Tax structure developments

According to folk wisdom, people joined in matrimony tend to look more like each other as time passes by. There is a presumption that this should also happen to the tax structures of the member states of a common market, such as the European Community (EC). As barriers to trade and factor movements are broken down, individual economies become more closely integrated. As a result, the nature and size of the major tax bases should become more aligned and with it the various tax handles to which individual taxes are attached. Moreover, increased competition in product and factor markets may enhance rivalry in taxation. By definition, discriminatory border taxes, such as import duties, are prohibited in the Common Market. As border controls are further relaxed, effective product tax rates of adjoining states and, by extension, of the whole Common Market might move closer to the Community’s average. Furthermore, differences in factor tax treatment should induce capital to move to countries with lower rates, which should act as a brake on too great a divergency in tax levels of individual Member States. Although differences in language and cultural traditions are important barriers, over time substantial differentials in the taxation of labor income might induce people to vote with their feet. Discretionary action, whether jointly or unilaterally, may accelerate these trends.

TOWARDS A NEW TAX COVENANT

SummaryIn The Netherlands, the high tax burden on employment income cripples the labor market, whilst the highly differentiated, if low, tax burden on capital income distorts the capital market. Building on the experience with dual income taxation in the Nordic countries, a new tax covenant is proposed comprising lower average and marginal tax rates on labor income and a more even-handed treatment of capital income. Specifically, capital income should be taxed at a low, proportional rate. Flanking measures are required to improve the workings of the labor market; notably, social benefits for people who can work as well as housing subsidies should be reduced. More fundamentally, a change in the social order is desirable which places greater weight on equal opportunities instead of equal outcomes.

VATs in CEE Countries: A Survey and Analysis

Ten Central and Eastern European countries have applied for membership of the European Union (EU). The adoption of the value-added tax (VAT) is a nonnegotiable condition. Accordingly, all these countries have introduced the VAT which, in principle, is a highly product-neutral, factor-neutral and revenue-productive tax. A review of the structures of the various VATs indicates that more can be done to tax public sector bodies and cultural services. In some countries, immovable property and the agricultural sector can be treated more even-handedly. However, the most important structural weakness of the VATs is the exemption and lower taxation of so-called essential products. VATs are ill-suited to enhance progressivity in tax burden distribution. It is concluded that policymakers should now focus their attention on improving the administration of their VATs. As in many other countries, tax policy often is tax administration.