Indirect Taxation within the EU – Harmonisation vs. Competition

Table of contents

Table of figures

Table of abbreviations

1 Introduction and purpose of the paper

2 Definitions
2.1 Indirect Taxes – definition and relevance
2.2 VAT – definition and relevance
2.3 Excise duties – definition and relevance

3 Fiscal policy within the European Union

4 Diversity of fiscal systems within the EU member states

5 Harmonisation vs. Competition

6 Harmonisation of indirect taxation
6.1 VAT
6.2 Excise duties

7 Conclusion

8 Future prospects

Reference List

Figures

Table of figures

Figure 1: Structure of tax revenues by major types of taxes; 2006, in % of the total tax burden

Figure 2: Volume and structure of compulsory taxes and social security contributions as % of the GDP (EU-15; 1997)

Figure 3: Implicit tax rates on consumption in the EU-25; 1995-2006, in%

Figure 4: Proportion of indirect taxes in % of the GDP (EU-15; 1997)

Figure 5: VAT/ GST EU-27 (2007)

Figure 6: VAT rates in the MS (2006)

Table of abbreviations

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1 Introduction and purpose of the paper

The European Union (EU), which was established by the Maastricht Treaty (February 7, 2002), is based on the several European Communities¹ (Wilke 1997: 178) as well as on the political structure and the cooperation of the Member States (MS) which were both introduced by the Treaty. While on the one hand, the EU targets the development of a competitive Single European Market, the other objective, to establish an Economic and Monetary Union, has already become a reality. Therefore, continuous non-inflationary economic growth, as well as a high level of employment and standard of living, needs to be fostered. Furthermore, the cooperation between the MS among one another should be encouraged, as it provides the basis for economic and social coherence as well as for solidarity. Hence, to realise the principles which are anchored in the Treaty, an adequate fiscal environment needs to be created. This process of fiscal harmonisation is one of the main challenges for the EU (Wilke 1997: 178).

The topic of fiscal policy becomes particularly important, as taxes can be interpreted as the basis of governmental sovereignty – there are no politics without means. Taxes and social security contributions strongly influence patterns of saving, consumption, investment and employment, and thus shape the operation of markets for goods, services, capital and labour; with impact not only on the domestic economy, but also on neighbouring countries. All in all, there is a notable importance of fiscal policy in all MS, as fiscal policy can be used as an instrument to govern economies.

While the economic integration of the EU is already on an advanced level due to the establishment of the Single Market and the European Monetary Union (EMU), it can be stated that some significant fields are lagging behind. Amongst others, the harmonisation of indirect taxes within the EU is a controversial topic (Genschel 2002: 16, Randzio-Plath 1999: 665). Any fiscal harmonisation hardly alludes to the funding basis of the public budget of the several MS. In the range of indirect taxes, value added tax (VAT), which is especially problematic for allocation politics, is already harmonised on a high level, while at the same time other excise duties were harmonised only hesitantly.

Since the enlargement of the EU in 2004, the public discussion on tax competition in Europe has become much more intensive, although the discussion is not a new one, as the topic was already dealt with by the Ruding Committee² (Fuest 2006: 4). Tax rates and systems are always the focus of comparison and also have to withstand international competition influenced by increasing globalisation. In this context, the increasing mobility of capital is a fact that cannot be left unconsidered, even by the fiscal legislator (BMF 2004: 36).

The aim of this paper is to examine the question of whether there is more harmonisation than competition in the field of indirect taxation in the EU. In general, the paper will deal with the question of what fiscal harmonisation actually is and which consequences can arise from a situation of competition for the government. Firstly, some definitions shall be given. After a brief overview about the fiscal policy within the EU, the diversity of fiscal systems among MS will be highlighted. The question of competition or harmonisation in general will then be stressed. Next, the current status of harmonisation with regard to VAT and other excise duties will be described in more detail. After a conclusion, future prospects shall be outlined.

2 Definitions

2.1 Indirect Taxes – definition and relevance

In contrast to direct taxes, indirect taxes are levied on production and consumption and are not borne by the ‘taxable persons’ (traders or industry) who pay them. Therefore, the tax is collected on behalf of the government and is passed on to the final consumer price, on which the burden falls (VAT and excise duties). This ‘theory of transfer’ means that the person liable for tax and the ultimate taxpayer are not identical (Hagen 2000: 25). However, a classification only based on the criteria of ‘passing on’ can be considered insufficient, as sometimes it is not possible to pass on the taxes to consumers based on grounds of competition. Therefore, a classification on the basis of the will of the legislator is proposed. Indirect taxes are those for which the taxpayer and the liable tax person are not identical (Hagen 2000: 27 et sq.). In previous years, indirect taxes have been the most important taxes on the EU level; their share in 2006 accounts to 39% (see figures 1 and 2). Moreover, the broad stability in the implicit tax rate (ITR) on consumption in the EU-15 from the early 1970s until the early 1990s can be seen in figure 3. Although taxes on consumption decreased from 38.4% in 1965 to 31.9% in 2005 within the OECD countries, they still constitute the highest share of major taxes on the whole (OECD 2007: 2).

2.2 VAT – definition and relevance

VAT is a general consumption tax which is directly proportional to the price of goods and services. It is collected fractionally, that is, on each transaction in the economic chain, and it is neutral. VAT was one of the first harmonised taxes within the EU, at least with regard to its framework.

VAT constitutes a special case with regard to the approach of fair tax competition. VAT is neither faced with a public benefit for the purpose of equivalence taxation, nor is it necessarily a civic affiliation or a territorial income affiliation like the case for withholding taxes is. Hence, VAT competition within the Single Market results, as consumers (citizens or companies) are able to relocate their buying decision to a place with a lower VAT burden. Thereby, VAT is a transit item for companies, which is why it is, in the end, a tax on private buying. As in other areas of EU fiscal policy, the Single Market has also been the most stimulating factor for the previous development of VAT. Differences in tax rates and tax bases have been regarded as obstacles for concerted action; hence, a policy of harmonisation aimed at EU-wide common tax rates and tax bases has been defined as a common purpose (Glasmeyer 2006: 132 et sq.).

In the context of indirect taxation, VAT can be interpreted as the most important income resource for the EU MS; e.g. in Germany the VAT accounted for about 31.5%³ of the budget in 2007. Not surprisingly, the VAT component of the ITR is the largest, as illustrated in figure 4. Nevertheless, the non-VAT component of ITR is far from negligible in nearly all MS; it ranges from 27.7% in Sweden up to 45.5% in Hungary (Eurostat 2008: 60).

2.3 Excise duties – definition and relevance

Excise duties concern indirect taxes on consumption or use of certain goods. In contrast to VAT, excise duties are typically specific taxes, i.e. they are usually specified as an amount of money per quantity. Excise duties have been subjected to harmonisation in the following product categories: tobacco products, alcohol, alcoholic drinks, and energy products (e.g. fuels like crude oil and gas, electricity, natural gas, and coal). All EU MS levy excise duties on these categories of goods. Furthermore, the excise duty revenues are accrued to the MS in their entirety. The tax revenue from the a.m. main excise duties amounts to about 90% of the EU-wide excise tax revenue. Therefore, the discussion about excise duties can be limited to these tax objects. The aim of EU fiscal policy is to bring about common excise taxation to let the cross-border trade flow smoothly and to abolish distortionary effects. Hence, the main goal is also to implement the Single Market principle. Nevertheless, the current problem regarding excise duties is finding a balance between the sovereignty of MS and the containment of tax rate competition (Glasmeyer 2006: 139).

3 Fiscal policy within the European Union

In comparison to other commercial markets in the world, the European Single Market provides a competitive and strong trading platform. Therefore, to continue with the establishment of the Single Market and the finalising of the EMU, basic objectives in the area of general taxation have been defined; i.e. that the duties of the EU comprise, amongst other things, the remedy of obstacles between the MS concerning the free movement of goods, labour, services and capital. Moreover, the EU has to ensure a system which protects competition within the Single Market against falsification. In this context, the adjustment of domestic laws is also a central duty of the EU (Wilke 1997: 178). These objectives should be realised as far as it is necessary for the smooth functioning of the European Single Market.

As the establishment of a Single Market (art. 2 TEC) and the protection of competition in the Single Market against distortion (art. 3 para. 1g TEC) are defined as tasks of the European Community (EC), fiscal harmonisation has been an important issue since the 1960s. Fiscal harmonisation in general means the adjustment of tax type and tax rate. It can be affected by an according action of the EC bodies and also through decisions of the European Court of Justice (ECJ). The legitimacy of fiscal harmonisation initially results from the principle of conferred powers (art. 5 para. 1 TEC) and the principle of subsidiarity (art. 5 para. 2 TEC). As long as there neither fiscal harmonisation nor fiscal coordination happens, fiscal competition occurs. This can be interpreted as a specification of common competition for local conditions, which is based on the different national characteristics of MS, assured in art. 6 para. 3 TEC.

The legal foundation for the EU fiscal policy can be found in articles 95 to 99 TEC, although the TEC contains only a few fiscal regulations, e.g., article 95 TEC deals with the prohibition of discrimination, and article 96 TEC defines the prohibition of an excessive refund of inland duties. However, the most important regulation for fiscal policy can be found in article 99 TEC, where the call for harmonisation in the fields of VAT, excise duties and other indirect taxes was defined to counteract distortion of competition within the Single Market. Based on this, the MS decided on specific directives for these duties, which have been successfully implemented into national law. Consequently, the system and structure of these taxes are already highly harmonised, though variations still exist, e.g. with regard to tax rates or certain tax exemptions. However, a prerequisite for fiscal harmonisation is the principle of unanimity within the Council of Ministers, which at the same time can be interpreted as a crucial obstacle concerning the progress of harmonisation.

4 Diversity of fiscal systems within the EU member states

Within the EU, the MS are largely responsible for their fiscal policy according to their administrative structure and composition. They can delegate this competence partly to regional or local levels. Within the area of taxes and social contributions, community measures are not aimed at standardisation state structures of levies systems, but rather at bringing the state systems in line with the TEC. The differences within the duty revenues and their structures are displayed in figures 1 and 2, which show explicitly the differing relations and therefore the diversity of tax systems. These differences within the several tax revenues are mainly caused by the kind of public funding of the main areas (education, pension provision and health). For example, a good portion of spending for pension or health can be carried out by contracting additional insurances which are not displayed in the public budget. According to article 269 TEC, the community budget spending is financed by tax revenues of the several MS, i.e. the MS conduct agricultural duties, customs duties, a proportion of their VAT (calculated on the basis of a harmonised assessment basis) and also an amount calculated on the basis of GDP to the community budget. The EU itself does not have any authority to levy or to adopt taxes. Rather, it is reviewed within the Single Market if the state tax regulations do not distort competition or hinder the free movement of goods, services and capital.

As a.m., unanimous decisions of MS are necessary; therefore, the fiscal political process of harmonisation and coordination within the EU takes place very slowly (EC 2000: 5 et sqq.).

5 Harmonisation vs. Competition

The dispute concerning tax competition is embedded in the general discussion on globalisation, particularly with regard to the processes that are combined in the term “globalisation”, which contribute to the fact that national borders as obstacles for economic activities or relocation of production factors become less important. In this context, decreasing transport and communication costs as well as reducing tariff and non-tariff barriers in the framework of the World Trade Organization (WTO) and the EU are conducive to internationalisation. In Europe, the monetary segmentation of the single market as a consequence of the currency has been resolved by the implementation of the Euro. Finally, even this last change is the cause for an increasing intensity in the discussion of fiscal competition.

Under certain conditions, fluctuating competition prospects between MS could be a prerequisite for the functioning of the Single Market. With the abolition of borders within the Single Market, fiscal competition could even bring an automatic harmonisation into effect by enforcing the best state fiscal system. Thus, the common level of the Single

Market could be improved. Admittedly, to achieve these positive effects, the fiscal competition has to be ‘fair’. Unfair fiscal competition happens particularly in cases of fiscal inequality, in cases of tax incentives only for non-residents or when the tax rate is reduced towards null. Conceivable consequences of such unfair tax competition could be that public revenues would be minimised and therefore, poverty within several or nearly all MS could result. Hence, there arises a political demand on the EU to participate in the financing of public responsibilities, in particular in the form of funds. Such a self-encompassed policy of ‘indigence’ of MS would be contrary to the principle of subsidiarity (art. 5 para. 2 TEC) and also in conflict with the commitment for solidarity between MS (art. 1 para. 3 TEU). Therefore, it has to be rejected emphatically.

To argue either for harmonisation or for competition with regard to globalisation, the underlying circumstances have to be taken into consideration. In Europe, several peculiarities of national fiscal systems were formed at a time which was characterised by compartmentalisation and protectionism. The modern tax and welfare state was essentially affected during the 1930s, in a time when national borders often formed insuperable obstacles for the free movement of capital and work. Only since the 1970s has the gradual opening of industrial countries as well as emerging and developing markets occurred. Although there was already a kind of globalisation around the turn of the century referred to by economic historians, there was not any tax authority which could be quantitatively compared with the modern state and its tax and duty burden. Therefore, we can learn only a little from this era concerning the question of consequences of globalisation for public finances. However, the combination of globalisation and massive redistribution and production activities of the state is new. Therefore, the estimated uncertainty is currently relatively high (Heinemann 1999).

Hence, to estimate fiscal competition, two major fields of governmental activities need to be taken into consideration. With regard to the field of allocation of public goods, tax competition could lead to an inefficient supply of public goods. Secondly, concerning the redistribution in the framework of a social welfare state, tax competition could be used to endanger the social state. The second assumption is closely connected with the question of fair or even unfair politics of location. Besides possible problems concerning the financing of an ideal level of public goods, the politics of location can also be interpreted as a danger for the modern welfare state. This argument is based on the assumption that tax competition can deprive the welfare state of its financial basis (Heinemann 1999).

6 Harmonisation of indirect taxation

Within the field of indirect taxation, the most fundamental changes have taken place since 1992. These changes include the implementation of the new excise duty and VAT regulation, which are based on the abolition of tax and tariff walls.⁴ While the revenues from indirect taxes can be recognised as relatively stable during the last several years, the proportion of the several indirect tax types diverge notably, which can be seen in figure 4.

As the harmonisation of VAT can be characterised as being ahead of its time, the next section will focus on this issue.

6.1 VAT

With regard to the fiscal harmonisation of VAT, not only the question of tax rates becomes crucial. The issue of the place of taxation also plays a – if not the – major role and was already the focus of the first directive, though it has not been accomplished. While the taxation in the country of origin is already effective with regard to private purchase, corporations by contrast have to pay VAT in the country of destination.

Within the European countries, VAT had been designed as excise duty which should exclusively burden the consumer as the ultimate consumer. However, if the ‘origin principle’ is used, it acts as a domestic severance tax, as all domestically produced goods are subjected to VAT – regardless of whether they will be consumed inland. Based on this conflict of the ‘origin principle’ with the national conception of VAT as excise duty, the interplay of the European VAT systems was developed towards the ‘destination principle’. According to this principle, only inland-consumed products need to be taxed in the country of origin (imports and domestically produced and consumed goods). Therefore, to deal with the ‘destination principle’, a border tax adjustment is necessary for exports, whereby the tax, paid in the country of origin, had to be balanced as an exportation refund. Consequently, imports have to be debited afterwards by an import turnover tax. For the Single Market, this border adjustment constitutes an obstacle, as the free movement of goods is constrained by it (Glasmeyer 2006: 133 et sq.).

The harmonization of VAT has taken place on three levels: the adjustment of the fiscal systems, the standardisation of the tax basis and the adaptation of tax rates.

As early as 1967, the Council of Ministers passed the first (67/227/EEC) and second directives for harmonization of legal provisions of the MS concerning VAT. In the course of these directives, VAT was modified from being a cumulative gross VAT to becoming an all phases net VAT with the right of deduction of input tax. All MS were obliged to implement these provisions by 1970⁵. Additionally, the second directive had defined the structure modalities for the application of VAT but offered great scope to the MS in important fields, e.g. the level and number of tax rates or tax exemptions (Genschel 2002: 70 et sqq.).

On the second level, a common VAT taxable base was first achieved in 1977 through the 6th VAT directive (77/388/EEC).⁶ Therefore, this directive can be interpreted as a kind of expansion. Moreover, the implementation of this directive was necessary to transfer a council order, whereby the common budget should be financed from its own resources only from 1975. Amongs other sources, the funds consist of a percentage of the VAT taxable base. The main problem of this directive was the method of imposition, which was too complicated and complex (Genschel 2002: 89 et sqq.). Moreover, despite the positive implications of the directive, the limitation of national sovereignty had been criticised, especially with regard to the meaning of article 33 para. 1 (Hagen 2000: 179)

As the border controls, which formed an obstacle for the Single Market, were not abolished, new discussions came up at the beginning of the 1980s. These efforts resulted in the ‘White Paper on the completion of the internal market’ (KOM (87) 328), in which the commission demanded the abolition of material barriers and the comprehensive equal VAT treatment of all purchase transactions within the Single Market (EC 1985: ref. 168). The ‘white paper’ set out a timetable for the measures required for the completion of the single market by December 31, 1992 at the latest. Since neither distortions of competition nor redistribution of VAT revenue seemed acceptable, the ‘white paper’ arranged for the implementation of a modified ‘origin principle’ with two additional measures: the harmonisation of the VAT burden and the implementation of a clearing mechanism (EC 1985: part 3). The premise of this clearing mechanism was to ensure a constant VAT revenue for all MS. Therefore, the revenues needed to be divided according to the ‘destination principle’, which was completely controversial (Genschel 2002: 99). Regardless of the meaning, the implementation of the ‘white paper’ induced serious consequences for the MS: adjustment costs, flexibility losses and losses of control. Hence, the ‘white paper’ was taken cautiously and the fiscal harmonisation took a back seat (Genschel 2002: 105). As the efforts in 1987 to move to origin-based taxation (also for corporations) were ruled out because of the inability to agree on a clearing system or to align rates, an interim solution was constructed by combining both origin- and destination-based taxation. Since 1993, private purchases have been subject to the former and commercial purchases to the latter. Only the purchase of new vehicles and mail order sales are exempted from these provisions (Genschel 2002: 108 et sqq.). In 1996, the EC proposed again a package of measures moving towards a common origin-based VAT-system which has not yet been implemented.

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¹ The basic Communities of the European Union are the European Community, the European Community for Steel and Coal and the European Atomic Energy Community.

² The Ruding Committee - which was an independent external group of experts - presented (on behalf of the European Commission) in 1992 a report on the harmonisation of corporate income tax in the European Community.

³ http://www.bundesfinanzministerium.de/nn_4158/DE/BMF__Startseite/Service/Downloads/Abt__I/060222 1a6009__Steuerarten__2006_E2_80_932007,templateId=raw,property=publicationFile.pdf

⁴ Cf. http://europa.eu/scadplus/leg/de/s10000.htm.

⁵ Cf. http://eur-

lex.europa.eu/smartapi/cgi/sga_doc?smartapi!celexplus!prod!DocNumber&type_doc=Directive&an_doc=1 967&nu_doc=227&lg=en.

⁶ Cf. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31977L0388:EN:NOT.