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The consequences of the Eastern Enlargement for
the tax policy in the old and the new member
states
Deniz Enhos ? Tatjana Lampreht ? Nina Paustian
Eastern Enlargement WS 06/07 Europa Universität
Viadrina
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Overview

• 1. (Corporate) tax competition in the enlarged EU
  from the point of view of Germany
• 1.1 Does a race to the bottom and a subsequent
  break in of the national tax income take place?
• 1.2 Do the new member states play unfair in
  the corporate tax competition?
• 1.3 Harmonisation
• 1.4 Conclusion
• 2. Consequences of the enlargement for the tax
  policy of the new member states
• 2.1 Taxation basics
• 2.2 EU enlargement and taxation
• 2.3 Harmonization
• 2.4 Comparison
• 2.5 Different taxation trends among the new
  members
• 2.6 Conclusion

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1.1 Does a race to the bottom and a subsequent
break in of the national tax income take place?
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Corporate tax rates in the enlarged Europe 2005
1.1 Does a race to the bottom and a break in of
the national tax income take place?
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Arguments which contradict a break in of the
national tax income
1.1 Does a race to the bottom and a break in of
the national tax income take place?

• Tax rates are only one aspect with regard to the
  choice of a site
• A break in of the national tax revenues have not
  occurred in Europe until now
• ? ratio of public spending to GNP
• ? quota of social services

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Arguments which contradict a break in of the
national tax income
1.1 Does a race to the bottom and a break in of
the national tax income take place?
ratio of public spending to GNP in Germany
quota of social services in Germany
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Arguments which contradict a break in of the
national tax income
1.1 Does a race to the bottom and a break in of
the national tax income take place?

• New member states (and also some old ones) do not
  suffer from a too low tax income although they
  have low corporate tax rates
• ? Relation of direct and indirect taxes
• Larger assessment basis, abolition of tax
  allowances

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Arguments which contradict a break in of the
national tax income
1.1 Does a race to the bottom and a break in of
the national tax income take place?

• tax income from companies in Germany grows fast
• ? No break in of the tax income because of
  competition

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1.2 Do the new member states play unfair in the
corporate tax competition?
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The reproach
1.2 Do the new member states play unfair in the
corporate tax competition?

• Its unfair that the new member states can
  afford such low tax rates and attract important
  investments. The tax rates must be harmonized!

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What does unfair mean?
1.2 Do the new member states play unfair in the
corporate tax competition?

• competition itself is not unfair or damaging
• a damaging competition is characterized by a
  decoupling of the place, where the taxes are paid
  and the place, where the economic activity
  proceeds
• ? distortions, unfair allocation of the tax
  income

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Approaches of the EU and the OECD
1.2 Do the new member states play unfair in the
corporate tax competition?

• OECD
• - tax havens
• countries that are able to finance their public
  services with no or nominal income taxes and that
  offer themselves as places to be used by
  non-residents to escape tax in their country of
  residence
• lack of effective exchange of information
• lack of transparency
• no substantial activities
• preferential tax regimes
• countries which raise significant revenues from
  their income tax but whose tax system has
  features constituting harmful tax competition
  countries which raise significant revenues from
  their income tax but whose tax system has
  features constituting harmful tax competition

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Approaches of the EU and the OECD
1.2 Do the new member states play unfair in the
corporate tax competition?

• EU
• - package of measures to fight harmful tax
  practices
• code of conduct for the taxation of companies
• taxation of interest payments to individuals
  residing in another member state
• transnational payments of interests and licenses
  between companies

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Approaches of the EU and the OECD
1.2 Do the new member states play unfair in the
corporate tax competition?

• Conclusion
• Both approaches do not eliminate the tax
  competition between the member states.
• They do not prevent relocations because of lower
  corporate tax rates.
• They do not call for a harmonization of tax
  rates.

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1.3 Harmonization
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Does a harmonization make sense?
1.3 Harmonization

• harmonization can only be achieved, if not only
  the tax rates are harmonized but also the rules
  to determine the earnings of a company
• ? against principle of subsidiarity
• ? reduces scope of member states
• ? every country has specific needs
• EU focuses on the abolition of national
  discriminating laws and on harmonization of the
  assessment basis of the national corporate taxes
• ? coordination of the different tax systems
• ? administrative costs would decrease
• ? more transparency

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1.4 Conclusion
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1.4 Conclusion

• competition does not endanger state income
• accordant to the OECD and also to the EU
  definition, the corporate tax competition is not
  unfair
• Most certainly, taxes should not be coordinated
  to institutionalize the shortcomings of the
  member states tax systems.
• ? reforms are necessary
• ? Germany has taken the first steps by
  introducing the tax reform

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Overview

• 1. (Corporate) tax competition in the enlarged EU
  from the point of view of Germany
• 1.1 Does a race to the bottom and a subsequent
  break in of the national tax income take place?
• 1.2 Do the new member states play unfair in
  the corporate tax competition?
• 1.3 Harmonisation
• 1.4 Conclusion
• 2. Consequences of the enlargement for the tax
  policy of the new member states
• 2.1 Taxation basics
• 2.2 EU enlargement and taxation
• 2.3 Harmonization
• 2.4 Comparison
• 2.5 Different taxation trends among the new
  members
• 2.6 Conclusion

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2.1 Taxation basics
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Taxation principle
2.1 Taxation basics

• As introduced by Adam Smith taxation takes place
  on the fields of
• A) ability to pay (wealth)
• B) consumption
• C) earnings

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Direct, Indirect and Corporate Taxes
2.1 Taxation basics

• Direct taxes corporation tax, income tax and tax
  on wealth. They are effective on taxpayers
  purchasing power
• Indirect taxes levied on consumption, they are
  effective on the process of goods and services
• Corporate Tax The Commission considered to
  propose a single corporate tax within the EU in
  order to prevent the distortion of investment.

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The principles of Origin and Destination
2.1 Taxation basics

• According to the principle of origin goods
  leaving a Member State (exports) are taxed and
  goods and services entering a Member State
  (imports) are untaxed
• according to principle of destination goods
  leaving a Member State (exports) are untaxed, and
  goods and services entering a Member State
  (imports) are taxed.

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2.2 EU enlargement and taxation
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Principles of Taxation through the Harmonization
process
2.2 EU enlargement and taxation

• The principle of neutrality in consumption
  taxes must be respected to eliminate states
  priority for national products.
• To prevent the tax rebates functioning as export
  subsidies the Commission proposed the VAT (Value
  Added Tax)
• Thereto, the Commission guaranteed a
  standardization in consumption taxes and made the
  economies of EU compatible with each other, and
  also in accordance to EU

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EU Enlargement and Taxation
2.2 EU enlargement and taxation

• Tax system plays a critical role to the business
  environment in a certain country
• The tax systems of the new Member States
  generated an increased tax competition and
  provide lots of opportunities for businesses
• The impacts of adoption of new taxation policy is
  both felt in NMS as well as they have strong
  implications on Old Member States.

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2.2 EU enlargement and taxation

• Most impacts in the new Member States derive from
  tax harmonization (different level of
  harmonization in different areas)
• Customs full harmonization
• VAT strong, general harmonization, the
  elimination of existing exceptions of certain
  goods and services from value-added tax
• Corporate taxes harmonization in certain areas
• Excise taxes Alignment to EU minimum levels

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Customs
2.2 EU enlargement and taxation

• Most harmonized area Customs Union New Member
  States had to renounce their bilateral Treaties
  (esp. on the road sector)
• Had to adopt full Community legislation for
  customs
• Customs tariffs in new Member States dropped from
  approximately 9 to approximately 4
• Transitional arrangements planning opportunity

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Value Added Tax (VAT)
2.2 EU enlargement and taxation

• New Member States had VAT systems before the
  enlargement, these had to be upgraded.
• Harmonization by means of Directives Many
  provisions are optional this results in
  differences between Member State VAT systems.
• Significant changes in compliance

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2.3 Harmonization
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The meaning of Harmonization for CEECs
2.3 Harmonization

• Upward adjustments in VAT, excise duties
• Increase in tax rates on energy and fuel in
  several countries
• Increase in tax rates on cigarettes in all
  countries(a preventiv policy before illegal
  border-cross trade)
• However, the rates are still much lower compared
  to EU-10 since the adopted rate was minimum rate
  in EU.

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Benefits of Harmonization
2.3 Harmonization

• Reduced subsidies to energy sector
• The removal of agricultural subsidies
• Both have a positive effect on fiscal balances!

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Areas of convergence and divergence
2.3 Harmonization

• Big differences in terms of corporate and capital
  income tax-divergence
• Whereas the capital taxes provided the main
  source to EU taxation, in NMS the main source is
  indirect taxes-divergence
• Small differences in labour income tax,common
  custom tariffs-convergence

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Main Problematics
2.3 Harmonization

• High income tax
• High public spending 42
• (in hand with inefficient use of resources)
• Low corporate tax
• (29.6 in EU10, 20 in EU10)
• Reasons cost of transportation, compensation,
  to attract the flow of FDI

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2.4 Comparison
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A general comparison of EU 10 with old member
states
2.4 Comparison
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Results drawn by Accession 2004
2.4 Comparison

• First, the new Member states have in common
  significantly lower tax ratios than the old EU-15
  and even display different trends over time.
• Secondly, different movement in taxation rates
  were observed, while in the EU-15 tax ratios
  generally increased until the turn of the century
  and declined afterwards, in the NMS-10 the
  opposite occurred.

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The economic Growth in New Member States
2.4 Comparison

• As another important point , economic growth has
  been substantially different in the EU-15 and in
  the NMS-10
• in the 1995-2004 period, the latter group's
  GDP, although starting from a low level, has
  grown about twice as much as its EU-15 equivalent
  (41.1 vs. 22.4)

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The explanations to lower tax rates in NMS
2.4 Comparison

• Whereas the main source to EU consists of capital
  taxes, business income taxes the rate in EU 15 is
  below in compare to EU10. Reasons
• A) lower aggregate value of capital
• B) lower productivity of capital stock
• C) limitations to capital stock
• As a result, the new member states rely on
  consumption taxes for 37.3 of the total against
  29.5 for the EU-15.(exception Czech republic)

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The low rate of direct taxes in new member states
2.4 Comparison

• In new member states the direct taxes percentage
  in taxation remains at a much lower level.(high
  cost of transportation)
• In 2004 the difference between the EU-15 and the
  new Member States averages was about 10
  percentage points (36.0 vs. 25.7 ). With the
  exception of Malta, all the new Member States are
  below the EU-15 average.
• especially in Hungary (24.2) , the Czech
  Republic and Slovenia (19.8) where lower level
  of the corporate and personal income taxes are
  levied.

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The level of Corporate Tax remains below
2.4 Comparison

• The level of corporate Tax is also lower than the
  EU average.
• The Czech Republic consists an exception for
  this category of taxation, where their share is a
  factor 1.2 higher than in the EU.
• A questionable argument There is a need for
  increasing the low level of taxation in NMS, in
  order to finance the development of their
  infrastructure or to cope with higher costs of
  their social protection and health care systems,
  but is it so in reality?

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2.5 Different taxation trends among the new
members
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Different taxation trends among the new members
2.5 Different taxation trends among the new
members

• In the Period of 95-99 the new member states
  followed a general decreasing trend in taxation
  rates.After 99 different trends are followed
  among the NMS.Slovenia and Hungary have the
  closest tax rates to EU-15 average, whereas the
  three Baltic states tax rates are even lower than
  the EU-10.Slovakia stands out as the Member which
  carries out as the most restructuring of its tax
  ratio, its tax ratio declined one quarter from
  average in 1995 at 40.5 of GDP, to having the
  fourth-lowest ratio in the EU-25 in 2004.

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The Graph of different trends in taxation
2.5 Different taxation trends among the new
members
The Graphic shows level in 1995 and change of
tax-to-GDP ratio until 2004
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Two Groups in NMSs
2.5 Different taxation trends among the new
members

• Within the NMS-10 one may distinguish two groups
  of countries, one composed of Slovenia (39.7 )
  and Hungary (39.1 ) with a level close to the
  EU-15 average (40.3 )
• and another group consisting of the remaining new
  Member States with a level substantially lower
  than EU-15 average from the Czech Republic (36.6
  , i.e. some 3 1/2 percentage points below EU-15)
  to Lithuania (28.4 , i.e. almost 12 percentage
  points below EU-15).

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Public Capital and Investment
2.5 Different taxation trends among the new
members

• Is there a positive relationship between the
  public capital and investment and increase in tax
  rates? NO!!!!!!
• In the field of public capital and investment
  expenditures a comparative analyses of OEEC
  countries shows that the expenditures of Central
  European and Baltic accession countries relative
  to GDP are on average higher than those of EU
  countries as a whole,

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Public Capital and Investment
2.5 Different taxation trends among the new
members

• A country-by-country analysis of public
  investment spending, based on the Pre-Accession
  Economic Programs, the PEPs (2002), shows public
  investment spending in 2002 ranges from 2.3 to
  5.0 of GDP in the Central European and Baltic
  countries, with Lithuania, Slovakia and Slovenia
  at the lower end of the range (below 3 of GDP)
  and Hungary and the Czech Republic at the higher
  end (at or close to 5 of GDP).

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2.6 Conclusion
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To conclude
2.6 Conclusion

• High income taxes high public spending
  (divergence)
• Low capital taxes, low corporate taxes
  (divergence)
• Convergence labor incomecustomto a certain
  level VAT and excises
• Q1 Increased tax competition but are they
  ready?
• Q2 Increase in tax rates increase in public
  spending is it so in reality?

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Thank you for your attention!
Deniz Enhos ? Tatjana Lampreht ? Nina Paustian