Market efficiency aspects

If one extends the reasoning put forward by Olson (1969), initially set in terms of assignment of expenditures, a modified ‘principle of fiscal equivalence’ would look at the location and mobility of tax bases and tailor the assignment of tax powers among different government levels to the various degrees and span of mobility. Choosing a new own resource could create the opportunity to assign revenue-raising powers for the EU to areas where the mobility of the tax base is higher. Thus, while a legal or private person may avoid a tax in one country by shifting to another, the impact could be neutralised by a supranational tax. Offering the EU the capacity to raise its income from mobile tax bases could enable the improvement of the overall taxation system, with Member States not needing to use revenue from less mobile tax bases to finance the EU. An overall efficiency improvement is thus possible and addresses some of the concerns about unfair tax competition and tax evasion. This would require a common tax base, such as the common consolidated corporate tax base (CCCTB) that has been proposed by the Commission. It would provide clarity and transparency on the effective tax rates.

7.1.1.1 Improving the functioning of the EU single market

Economic analysis of taxation deals extensively with the effects of tax instruments on incentives, and hence on private sector choices to supply work, to save and consume, to invest, etc. Two instruments do not fall victim to such effects on incentives, namely the taxation of economic rents and lump-sum taxes in general. However, for the EU such taxation as an own resource is for two reasons not appropriate. First, the EU is not rich with natural resources, which makes one major source of rent-taxation unavailable and the resources tend to be location-specific, making such a tax controversial and most likely resisted by countries owning the resource.

The other option is imposing levies on other economic rents, which is difficult in practice, but would be in some specific cases rational at the EU level. It may be argued that whenever public policies generate benefits to some categories of private agents, the induced rents may be partially taxed away, a principle close in theory to the notion of user charges. Although difficult to evaluate, these policy-induced economic rents certainly exist in the EU single market. Hence, some have argued in favour of taxing the benefits accruing to firms from the existence of the single market. But in theory this can be expanded, as such benefits should be very widespread, and accrue not only to firms, but also to consumers.

Resorting to lump-sum taxation, either at the level of individuals or of Member States may be tempting, but would undoubtedly be vigorously opposed by many on equity grounds, as has always been the case with attempts to use lump-sum taxation in a national context – and as Margaret Thatcher learned to her cost after introducing a poll tax to finance local government.

Apart from such taxes, it is recognised that all forms of taxation introduce relative price distortions that may generate inefficiencies in the allocation of resources by the private sector and deadweight losses. Hence, it is impossible to conceive of a tax system that is costless. But economic analysis also demonstrates that this inefficiency is related to the magnitude of the price distortion, itself dependent on the marginal effective rate of taxation. Therefore, a tax

system that aims at minimising inefficiency should be characterised by broad bases and low marginal rates. In addition, as was demonstrated long ago by Ramsey (1927), the more price-inelastic the tax base is – i.e. the less it changes in reaction to relative price or tax rate modifications – the less inefficient the tax instrument.

Turning back to the Ramsey criterion, in the current European context, characterised by internally mobile tax bases, but also by the international mobility of some of them, the logic needs to be extended to the mobility of tax bases. Because some tax bases are obviously more mobile than others – one may especially think of financial capital and firms – assigning tax powers over these mobile bases to the EU level would entail the triple benefit of mitigating the Ramsey problem and lessening the pressure of horizontal tax competition (see, e.g. Le Cacheux, 2000; Saint-Etienne and Le Cacheux, 2005). It would reduce the magnitude of distortions introduced by the existence of different national tax bases and rates affecting the decisions of private actors on the location, and would lessen the possibilities of fraud or evasion. It would provide the EU budget with a resource that is levied over the whole area over which the benefits of European public goods accrue, thus minimising spillover effects, in the spirit of Olson’s fiscal equivalence. That being stated, the extent of the triple benefit has to be put into the perspective of the relatively small size of the EU budget. Still, the effort of creating common tax bases could help Member States in improving tax cooperation efforts regardless of the size of the EU component of the taxes.

7.1.1.2 Remedying market failures

In a number of well-defined circumstances, efficiency may imply deliberately introducing price distortions: whenever there are negative external effects, market prices do not properly reflect social costs, and the so-called ‘Pigouvian’ solution to restore efficiency entails introducing distortionary taxation in order to correct externalities and produce the right incentives; this is the well-known case for many forms of environmental taxation. Two distinct arguments can be put forward for such taxes to be decided and operated at the EU level rather than at the national level: one is the collective decision-making argument, in terms of potential free riding; the other is in terms of the smooth functioning of the EU single market and ensuring a level playing field for private agents operating in this integrated area. Even though it may be argued that many major environmental protection issues – and most prominently the fight against climate change – are worldwide public goods, they clearly also have a European dimension, especially if the EU is to take unilateral action on some such policies. The EU’s commitments to reduce greenhouse gas emissions by 20% by 2020 and by 40% by 2030 are policy objectives that need instruments for implementation (Laurent and Le Cacheux, 2009).

The inability of the EU to introduce genuine own resources and its use of mainly a GNI-based resource restricts the EU in using fiscal instruments to promote changes in the market. There are fiscal incentives generated by EU policies, but the revenues are not accruing to the EU. The most interesting case is the ETS, which has such an effect and is a pure EU levy, but ironically does not contribute to the EU budget, with revenues remaining in the hands of national authorities.

7.1.1.3 Tax externalities and tax competition

Ever since the completion of the EU single market, tax competition has been on the rise. In the late 1980s, after adoption of the Single European Act, the Commission expressed concern that tax harmonisation might be needed, at least on some of the tax instruments most directly impacted by increased mobility of tax bases. Of particular concern was VAT, for which the 1991 Directive foresaw a switch from the destination to the origin principle, the destination principle

being maintained in the ‘transitory regime’ that eventually became perennial. Later on, in the late 1990s, renewed concern was expressed by the Commission and a number of Member State governments about ‘harmful tax competition’ in the fields of corporate taxation and the taxation of incomes from personal financial investments (Primarolo Report, 1999). As a response, two important measures were adopted: the ‘Code of Conduct’, prohibiting ‘damaging’ tax competition – essentially discriminatory tax treatment of foreign firms – on corporate taxation, and the Savings Directive (2003/48/EC), which introduced mandatory information exchange on incomes from interest-bearing assets held by non-resident EU citizens.

With further progress in completing the single market, and the increasing number and size of multinational corporations, as well as the building of trans-European networks for passenger transport (e.g. Eurostar and Thalys), the Internet and the development of firms selling services that cannot easily be located in one country or another, tax competition has apparently become more severe on the most mobile tax bases (Saint-Etienne and Le Cacheux, 2005). There has indeed been a ‘race to the bottom’ on statutory tax rates for high-income earners and corporations, as well as a persistence of discriminatory tax treatments, as revealed by LuxLeaks.

Since the 2009 Great Recession, tax competition has tended to grow worse, with the tendency of those eurozone countries caught in severe recessions and having to consolidate their public finances to resort to ‘internal devaluations’ – usually a mix of wage moderation, reductions in social contributions and consumption tax hikes. A ‘race to the top’ on VAT rates has also been observed since 2010 (Le Cacheux and Laurent, 2015).

Of course, tax competition is not necessarily bad, from an economic efficiency viewpoint. It undoubtedly has beneficial effects: by pushing rates down, it reduces the distortions on market price signals, and hence the deadweight loss generated by taxation, and may force governments to be more efficient in the provision of public goods and better cater to the preferences of their citizens. But in the presence of discriminatory tax treatments, there are – often large – efficiency losses due to distortions in firms’ location decisions and other costs related to efforts by firms to

‘optimise’ their tax burdens, as exemplified by the recent cases of tax-motivated mega-mergers.

In addition, a robust conclusion of the literature on horizontal tax competition (i.e. competition among governments at the same level in a multitier government structure) is that, with a limited number of governments competing for a mobile tax base, the equilibrium outcome will be suboptimality in the provision of public goods – insufficient in volume and quality compared with an equilibrium with centralised taxation – owing to the existence of horizontal tax externalities.⁴⁸

When tax bases are shared among governments at different levels in a multitier government structure – such as a federation or the EU – a vertical tax externality also exists, in the sense that decisions to tax at one level will have an incidence on the size of the tax base for governments at other levels. This creates a strategic interdependence, whose effects in general counteract those of horizontal tax competition; hence, vertical tax competition tends to mitigate the race to the bottom induced by horizontal tax competition and may partially restore optimality in the provision of public goods. The literature on vertical tax competition is more recent and less abundant than that on horizontal competition (Annex II); the conclusions are less clear-cut and it suggests that outcomes depend to a large extent on institutional design and informational

48 See Wilson (1986) and Zodrow and Mieszkowski (1986); for a survey of theory and evidence in the EU, see Saint-Etienne and Le Cacheux (2005).

structure. But the general conclusion that introducing a more centralised power to tax mitigates the inefficiency in public goods provision is broadly valid.

7.1.1.4 Efficient stabilisation and growth

The case for equipping the EU budget with instruments, especially on the revenue side, that play a role in macroeconomic stabilisation has long been made in some quarters, at least since the MacDougall report (1977).⁴⁹ The case for having automatic stabilisers, especially on the revenue side of the budget, has been restated forcefully with new arguments (see, in particular, Aghion and Marinescu, 2007; Dullien and Schwarzer, 2007) and the difficulties of coordinating fiscal policies in the face of the 2009 Great Recession may be regarded as additional evidence in favour of a common stabilisation instrument (Le Cacheux and Laurent, 2015). Although facing the difficulty that some EU countries are not members of the eurozone, this would plead in favour of having a resource in the EU budget whose revenue is sensitive to business fluctuations.

Stabilisation may imply breaching the balanced budget rule by allowing deficit financing at the EU level, or else establishing some sort of ‘rainy-day fund’ that would be built up in good times and spent in bad times, thereby potentially raising problems related to political control and possible temptations to spend the money in good times.