TAX NEWS - June 2010

Taxation trends in EU: Corporate tax rate down from over 37% in the mid-1990s to around 26%; Europe's high-tax / welfare model has failed to shield people from economic crisis

Europe's high taxation and high-welfare model has failed to shield people from the global economic crisis and conflicting fiscal measures to tackle the crisis have not been the best response, the European Commission warned on Monday. The average adjusted statutory tax rate on corporate income has fallen from over 37% in the mid-1990s to around 26% now.

"Heavy taxation is usually believed to take a higher toll on growth during cyclical upturns . . . rather than in recession; yet, although the crisis originated in the US, it spread quickly to the EU and resulted in a slump of comparable proportions,"a  study published on Monday, says. "Does the crisis suggest that another fiscal policy model would have been preferable?"

The study says European Union is, taken as a whole, a high tax area. In 2007, the overall tax ratio, i.e. the sum of taxes and social security contributions in the 27 member states (EU-27) amounted to 39.8 % of GDP (gross domestic product - - in the weighted average); this value is about 12 percentage points above those recorded in the United States and Japan. The EU tax-to-GDP ratio is high not only compared with these two countries but in general; amongst the major non-European OECD members, only New Zealand has a ratio that exceeds 35 per cent of GDP.

Ireland had a ratio of 31.2% in 2007 down from 31.6% in 2001. However, because of the large presence of multinationals, Irish GDP is about 20% higher than GNP (gross national product) - - a more realistic measure. The majority of Irish private sector workers do not have an occupational pension and private health insurance is contracted for because of the lack of confidence in the public health service. Most people have to pay for routine doctor visits.

The Commission said overall tax burden decreased from 2000, but usually only for a couple of years. Efforts to reduce taxes permanently petered out gradually; reductions in tax ratios, fairly aggressive in 2001, lost importance in subsequent years and mostly stopped altogether in 2005. The study says cyclical factors contributed to this development; growth slowed in the years immediately after 2000, reducing tax revenue, whereas from 2004 onwards, growth in the EU accelerated again.

In addition, the need, in several countries, to reduce the general government deficit also made it more difficult to cut taxes. The high general average by no means implies that every EU member state displays a high tax ratio; on the contrary, ten member states had ratios below the 35 % mark. On the whole, the differences in taxation levels across the Union are quite marked; the overall tax ratio ranges over almost twenty points of GDP, from 29.4 % in Romania to 48.7% in Denmark. These differences do not only reflect social policy choices like public or private provision of services such as old age pensions and health insurance, but also technical factors: some member states provide social or economic assistance via tax reductions rather than direct government spending, while social transfers are exempted from taxes and social contributions in some member states but not in others.

The Commission said it should also be mentioned that the GDP value that constitutes the denominator of the overall tax ratio includes estimates of production by the informal sector (the 'grey' and 'black' economy); so that a low overall tax ratio may reflect not only low taxes, but also high tax evasion. As a general rule, tax-to-GDP ratios tend to be significantly higher in the old EU-15 member states (i.e. the 15 member states that joined the Union before 2004) than in the 12 new members: the first seven positions in terms of overall tax ratio are occupied by old member states. There are exceptions,  however; for example, Ireland's and Greece's tax ratios are amongst the lowest in the EU. The Eurozone (EA-16) shows a slightly higher overall tax ratio than the EU-27, which is not surprising given that it is mostly composed of old member states.

Corporate taxes have fallen sharply in the EU over the past decade. The average adjusted statutory tax rate on corporate income was over 37% in the mid-1990s, for example, and is now around 26%.

Officials say this reflects tax competition between member states and a growing desire to demonstrate that countries are "business-friendly" - - especially as lower-taxing accession states from central and eastern Europe have joined the bloc.

The study criticises the many tax measures governments took in response to the financial crisis, saying they "risked being incoherent," at a regional level.

It says it is too early to undertake a full analysis of the measures, but point out that the measures were diverse - - often consisting of discretionary tax cuts, but also involving revenue-increasing measures in some member states because of budgetary problems. For example, the UK and, to a lesser extent Finland, cut value-added tax rates,  while other countries, such as Hungary and Ireland, raised their VAT rates.