The age of small government is over. In two consecutive crises, governments had to step in when markets failed and had to directly support people and businesses during times of hardship. Given the big challenges awaiting us, including climate change and social inequalities, it is unlikely that government spending will soon reduce to pre-crisis levels. It is no longer a question of whether governments need additional sources of income. The question is, rather, where the extra income is to come from. Who will foot the bill for economic recovery and a sustainable economic transition? And how can we prevent the poorest members of our society once again taking the biggest hit? If we want to answer these questions in a way that is in line with our progressive values, it is clear that a strong level of EU cooperation is indispensable.
The triple challenge
Three main challenges are facing us. First there is the urgent challenge of protecting our economy. The 10 percent drop in the EU’s GDP due to the Covid-19 crisis is unprecedented in peacetime. But so has been governmental response. Across Europe businesses are supported and salary payments taken over on a massive scale. The rise in public debt of EU governments, estimated by the ECB to be some 20 percentage points, is not necessarily a problem in the short run. Yet to maintain the trust, confidence and belief of financial markets that debts will be repaid, Member States need to convince investors of sufficient future earnings. Given the uncertainty of future growth, additional taxation is the way to provide this assurance. Yet the ongoing race to the bottom in tax rates and large-scale tax avoidance structures by digital companies and other multinationals has meant a rapid decrease in tax revenue for many of Europe’s governments. If we want to uphold trust and belief that this debt will be repaid, this issue has to be addressed.
The second challenge facing us is global warming. The risks are well documented and the public demand for action is pronounced. The role of EU tax policy in addressing this crisis is also of major importance. Indeed, governmental taxation and spending is necessary to guarantee sufficient resources for investments in renewable energy, insulating buildings and developing new technologies. It is also necessary as a way to change behaviour towards more sustainable activities. Flying, for example, is still subsidised and untaxed, and while we are starting to impose stricter rules on emissions from domestic production processes, polluting products made outside the EU can still enter the internal market with impunity. Polluters should be more effectively charged for the damage they do to our environment. Taxation and import levies are a key method of doing so.
The third challenge comes from unfettered capitalism and unregulated markets, causing inequalities to grow. According to the World Inequalities Database, the percentage of total income earned by the richest 1 percent in the EU has gone up from 7.3 percent in 1980 to 10.7 percent in 2017. This has come at the cost of the middle classes. The OECD has determined that, over the past 30 years, median incomes have increased 33 percent less than the average income of the top 10 percent. With house prices going up three times as fast as median income over the last two decades, middle class purchasing power has more or less stagnated. Part of this is the result of changing relative tax burdens. Tax avoidance and tax competition have led to lower (effective) tax rates on corporate profits, returns on wealth and high labour income. These are exactly the types of income that disproportionally accrue to the wealthiest. Any efforts to reduce inequality should thus incorporate a recalibration of our tax system.
Fortunately, the rise of progressive economic thought in the wake of the financial crisis means we have the policy responses required to face this triple challenge. And concrete steps have already been taken. At the initiative of the G20, the OECD has been tasked to prevent tax avoidance and tax fraud through its Base Erosion and Profit Shifting (BEPS) initiative. The first round of this initiative led to 15 action points to rewrite the global tax rules that have enabled multinationals to artificially move their profits to low-tax jurisdictions. A second round is currently ongoing with the aim of addressing fundamental issues that were ignored in the first round, so as to create a global floor in corporate tax rates and to redefine the allocation of profits made by (digital) companies. However, to put pressure on international negotiations, the EU needs to ensure that it stands at the ready with unilateral actions in case international talks fail.
And the EU stands at the ready. Through a definition of significant digital presence and a digital services tax, the EU has proposed rules for determining where digital companies should be taxed and at what rate. An EU digital tax can promote a fair tax system, reduce incentives for national government to provide sweet tax deals and generate real resources – up to 5 billion a year – to address EU priorities. However, other companies also avoid paying taxes, via the use of intra-group loans or transfer-pricing methods for the use of intellectual property to redirect payments to low-tax jurisdictions. As such, any digital tax must be a frontrunner for broader changes and ultimately be integrated in a complete overhaul of European tax rules through the Common Consolidated Corporate Tax Base (CCCTB). These rules would create a common set of policies for computing taxable income in the EU, thereby reducing complexities for cross-border companies and potential avenues for tax avoidance.
Progress has been made at clamping down on non-EU countries facilitating tax avoidance. After a persistent push from the European Parliament, the Council recently adopted a list of twelve “non-cooperative jurisdictions for tax purposes”. While upon its adoption there were no direct consequences for jurisdictions on this list, the fear of being publicly named and shamed by the EU has led countries around the world to implement necessary reforms. Furthermore, consequences of being on the list are fast coming. In the context of state support during the Covid-19 crisis, Denmark and Poland committed not to support companies having a presence in these countries without accompanying significant economic activity. Similar calls are currently being voiced in the European Parliament, making it likely that additional consequences for companies using tax havens will arise. The revision of EU state aid rules, for example, could introduce a ban on aid to companies using tax havens for fiscal reasons, unless they formally commit to closing them.
At the same time, the overall discussion has adapted to the growing call from citizens to address the issue of climate change, with green taxation assuming an increasingly important role. Through the EU’s Emissions Trading Scheme (ETS), we have a tool to get polluters to pay for the damage they wreak on the environment. However, this tool is far from perfect. Key sectors such as transport and heating cannot be effectively covered, and non-EU factories largely fall outside the scope of the ETS, creating unfair competition and a failure to address the worldwide scale of climate change. Taxation and tariffs can help here. The EU’s Energy Tax Directive (ETD), hailing from 2003, is soon up for review. This provides a chance to raise minimum levels of excise duties that have failed to rise in tandem with inflation and allows for aviation fuel to be taxed similar to other fuels. Furthermore, through a Carbon Border Adjustment Mechanism, the EU can level the playing field between importers of goods and EU manufacturers via import duties based on the amount of pollutants emitted in manufacturing a product.
The democratic costs of national sovereignty
While it is clear that we have the ideas needed to wield EU fiscal policy as a force for a more stable, just and sustainable future, their implementation remains a point of concern. This despite the clear wishes of EU citizens. Over 80 percent of citizens from six Northern European Member States think it is a good idea to tax large digital companies and 75 percent of Europeans want the EU to do more to fight tax fraud and tax avoidance. Yet we have seen that small Member States can use the unanimity required by the EU treaties to block proposals that the majority of Europeans clearly want. Member State insistence on national sovereignty thus comes at a great cost to democracy. Indeed, members of national parliaments are also increasingly in favour – or at least do not actively oppose – majority decision-making.
While in the short run individual countries might be pleased about being able to use veto powers to block progress, in the long run all lose out. The consequence of unanimity is a perpetuation of the status quo, and if politicians cannot adapt the rulebook to a rapidly changing world, the status quo loses its effectiveness. In the field of taxation, this means a continued "race to the bottom" between countries, ratcheting down to an even lower tax rate, a surge in tax avoidance and an increase in inequality. Large multinationals can decide where they make profits and pay corporate taxes. This puts individual countries under pressure to at least follow tax cuts by other countries pursuing a more aggressive low-tax policy. The only way is down. We need EU-wide standards to formulate alternatives. Only by limiting veto powers on taxation do these alternatives have a chance to see the light of day.
The way forward
While pushing for progress in the areas currently embarked upon, we should continue exploring other avenues for action. First of all, by focussing on EU countries facilitating tax avoidance. After the European Parliament in March 2019 adopted a list of seven “tax haven” EU Member States that facilitate aggressive tax planning, the Commission and Parliament now need to develop a clear action plan for each of these countries to bring them back in line with acceptable taxation practices. This involves imposing a floor on corporate tax rates of at least 18 percent on all profits made by a firm in that Member State, including on profits shifted to tax havens using, for example, interest and royalty payments. Beneficial tax regimes are a clear case of distortion of the conditions of competition in the internal market. It is high time that the European Commission starts addressing such distortions using the special ‘article 116 procedure’, for which unanimity is not required. When it does, the European Parliament stands ready to welcome it.
Another avenue for EU action is taxing those multinational enterprises that benefit most from the EU’s single market and ongoing efforts to protect this market in the face of Covid-19. While the removal of intra-EU trade barriers has massively reduced costs for enterprises operating across the EU, they have so far not been asked to contribute to its maintenance. With a small levy amounting to up to 250,000 euros for the largest businesses, the EU can raise over 10 billion euros a year and strengthen its efforts to create an integrated economic area. An alternative EU-level tax could be an excess profit tax on companies that have seen their profits increase significantly during the pandemic, such as supermarket chains. To allocate the cost of the pandemic fairly, wealth taxes should also be introduced across Europe, and we need to continue work on a Financial Transaction Tax to increase the contribution of the financial sector and reduce harmful speculative trading practices. A final area for EU action is a stronger regulation on the gatekeepers to our tax system: accountants, auditors, and tax lawyers.
A future-proof EU tax policy
The challenges we face are unique and growing. While naturally changes to tax policy alone will not be sufficient to address social ills, they are necessary. Without efforts to address tax evasion around the world, develop green taxation and start rethinking the way we tax digital companies, multinationals and the wealthiest Europeans, we will not be able to recover from the Covid-19 crisis in a fair and sustainable way. In the wake of the financial crisis, significant new ideas for fair taxation were developed. While some of these have been implemented, too many have not. The current sanitary and economic crisis shows that a strong government is necessary to protect our health, jobs and environment. They will need the tax policies to match. Let’s stop wavering and finally dare to properly tax our businesses and wealthiest citizens. The times have changed. It is high time that European tax policy followed suit.
Paul Tang is Member of the European Parliament since 2014, where he focusses primarily on fair taxation, digital rights and sustainable finance. Since September 2020, Paul Tang is chair of the Parliament's newly established fiscal affairs subcommittee.
The views expressed in this article are not necessarily those of Friedrich-Ebert-Stiftung.