Time for the Truth: EMU and Tax Harmonisation

Jonathan Collett 

As Britain watches the birth of the Euro and euro-integrationists advocate Britain joining euro-land as soon as possible it is surely time for an honest debate to begin? Many have forgotten the personal suffering and the huge disincentives to enterprise and investment induced by a culture of high taxation. They need to remember fast, before advocating such a colossal folly.

Whether by accident or design, many have misled when explaining the meaning of EMU and the emergence of a European Single Currency. EMU does not stand for European Monetary Union, as they have tended to suggest, but instead stands for Economic and Monetary Union. This is a crucial error to make and neglects one of the key effects of the introduction of EMU: the harmonisation of nations' economic and monetary policies and ultimately of fiscal and taxation policies. As the current president of the Bundesbank, Hans Tietmeyer, remarked in October 1995 "it is an illusion to believe that the States will retain their independence in fiscal policy."

In every other EU member, the single currency is seen as a political prize for which there may be an economic cost. The French Prime Minister and even the German Chancellor have admitted that EMU could be painful, at least in the short term. Only in Britain is the euro advocated on economic grounds. In order to make an economic case for EMU, supporters have had to exaggerate its advantages while glossing over its costs.

UK membership of EMU would drive up taxation. Those most closely involved with monetary union expect it to be accompanied by tax harmonisation. Under a single currency, transfer payments from the richer areas of the euro zone to the poorer areas will be the only way to offset downturns in the poorer areas, in the absence of flexible interest rates. Indeed, many European politicians support the euro precisely because they see it as a step to fiscal union, and thus to political union. The UK would almost certainly be a large net contributor under any over-arching fiscal policy. Britain today has the most competitive tax regime in the EU. Any harmonisation of fiscal policy would therefore damage British business.

Harmonising tax in the EU would involve the knotty problem of bridging the considerable gap between "Anglo-Saxon" and "continental" beliefs of the role of the state in society. Ultimately taxation rates will have to be harmonised upwards so that personal taxation levels in countries such as Britain will match those of France and Germany. A recent survey by the investment bank UBS on EU labour markets pointed out that the overall taxation of labour is very high in most western European countries in comparison with Britain. When Viktor Kilma, the Chancellor of Austria, took over the EU presidency last Autumn he stated that his top priority was more "European tax harmonisation" to help the single currency.

According to reports of the most recent European summit, a chorus of EU leaders said the answer to Europe's problems was "more Europe" not less. Tony Blair endorsed plans for finance ministers to consider multi- billion EU investments in infrastructure projects. Thirteen of the fifteen EU states now possess left of centre governments. EU spending and consequently taxation levels will rise in the face of such thinking.

The UK trading cycle is out of sync with that of continental Europe and is closer to that of the United States. Convergence has not occurred between the UK and other European economies and with British trade and investment increasingly taking place in a global context it is unlikely to do so in the future.

When tax rates were reduced in Britain in the 1980s business creation and the income from taxation rose. The private sector in Britain grew from 17.3 million employees in 1981 to 21.5 million employees in 1997. An increase greater than in any other country in Europe. The public sector shrank from 7.2 million employees in 1981 to 5 million employees in 1997. The UK economy was much healthier and competitive and a spirit of enterprise had been created.

There was also a reduction in the "brain drain" of highly skilled and experienced employees deserting British industry and commerce which had occurred because of the punitive taxation rates set by the British government in the 1970s. The highest rate of taxation had been 98% and the basic rate 35%. It seemed that we had learnt the vital lesson from this in the 1980s as the British economy recovered, entrepreneurial spirit was encouraged and talented scientists and entrepreneurs stayed at home. According to the OECD it is the USA which in the 1990s has the most successful record of attracting inward investment precisely because of its low level of GDP taken in taxation. Were Britain to take the opposite course and join the European social model we could well see a return to those dark days of the 1970s.

In 1996 Theo Waigel, then German Finance Minister, described London as a tax haven because low personal income tax in the UK had encouraged German financiers to move here. In October 1998, the telecommunications company Ericsson explained that its decision to move part of its business to London followed difficulties persuading executives to work in Sweden, because of high taxes. Why throw away such an obvious advantage? Skilled employees wish to have the freedom to spend their own hard earnt money. If they are denied the opportunity then they may well look elsewhere to find more favourable conditions of work in terms of taxation.

Economic and Monetary Union will inevitably affect fiscal policy by limiting budgetary independence both directly through the Maastricht convergence criteria and potentially via the Growth and Stability Pact. Consequently British subjects will lose the ability to influence democratically the measures that determine their levels of personal taxation and living standards, should the UK join the Single Currency. This power will instead be exercised by unaccountable EU bankers and bureaucrats, as the scope for national self-government is reduced. The European Central Bank is governed by bankers independent of national governments and the electoral process. They are prohibited by the Maastricht Treaty from consulting with, or being advised by, politicians when framing EU-wide monetary measures.

The result is that other countries will increasingly be able to decide Britain's tax strategy if the UK joins EMU. Any of EMU's economic benefits (no exchange rates, lower interest rates) will be cancelled by the significant increase in UK corporation tax (currently 31%) to match the continental average of 44%.

Whereas recent UK tax policy has lightened the burden and encouraged investment, continental taxes have risen. Harmonisation of EU member states' tax rates will mean higher rates for the UK, since other states are unable or unwilling to reduce the tax burden on their voters and institutional developments inside EMU will end the need for unanimity among European Union members over tax matters.

Regrettably, the UK, along with other EU states, signed a code of conduct pledging action on "harmful tax competition" in late 1997. The following day, Jean-Claude Juncker, leader of the European Parliament, announced that he expected the harmonisation of EU business taxes "within two years."

VAT harmonisation reveals the Commission's current strategy on tax. The Commission fully intends to set a single rate and this was revealed when the status of its VAT Committee was abruptly changed from being "advisory" to "regulatory" on 21st January 1998.

Indeed personal taxation in Britain could well rise by 50% from the present base rate of 23% to the mid to upper 30s in order to harmonise taxation upward within the Euro zone. At present the UK possesses the lowest Base and Higher rates of income tax in the European Union.

EMU will drive up borrowing costs for British business. British business has in the past had to pay a premium to borrow in sterling; but that was in the days of high inflation, when sterling was a weak currency. Today, real long-term interest rates are low in the UK, to the considerable benefit of British business. Ten year forward rates are now below German levels. And on current projections, British government debt will fall from 52 to 39 per cent of GDP over the next four years, which will drive long term corporate borrowing costs down still further. Were Britain to enter into a monetary union with states labouring under debts of 60 to 120 per cent of GDP, this advantage would be lost.

One only has to look at the effect of the social chapter regulations covering the rights and entitlements of employees in the work place which have ensured a standardisation of costs and obligations. These have not aided competition but have actively discouraged competition on costs, raised the barriers to entry in many sectors, have discouraged firms from taking on labour and have promoted the collective passing-on of the resulting costs in higher prices. On the EU's level playing field it is costs that tend to be levelled up, and investment and entrepreneuralism down.

A high tax, highly regulated and costed Europe will create a spiral of disincentives. If Britain joins EMU we will in effect be removing the very conditions which have aided our recovery of the last two decades and which at present give us a comparative advantage. At present we have the lowest rate of unemployment, the highest incidence of private sector employment, and the highest level of inward investment in Europe. In many ways we have forgotten what it is to possess a highly taxed, highly regulated economy. What is bad for business is bad for investment and bad for jobs. So it is not a question of whether we can afford to stay out but whether we can afford to join.

This article is also to be published in Euro Quarterly