Why Tax Harmonization in the Eurozone Is a Bad Idea

The Eurozone is one of the largest single markets in the world. It is unique in the respect that it is made up of many countries and yet can be considered to be one single market. The truth is that all different countries have their differing tax regimes. This is the reason why politicians in many countries in Europe have been proposing the harmonization of tax rates.

In this article, we will have a look at the reasons behind the harmonization of tax rates as well as some of the arguments that have been made against it.

The Reason behind Harmonization of Tax Rates

Leaders of some of the wealthy European nations have been upset with the legal tax evasion that has been going on in the Eurozone. According to them, the increased government debt is indeed a problem. However, institutionalized tax evasion seems to be a bigger problem for the governments of these countries.

For instance, Portuguese leader Anna Maria Gomes has stated that the amount of revenue lost due to tax evasion is more than enough to pay back the excessive debt that Portugal has. She has provided some figures which show how companies use different tax rates in the Eurozone to evade taxes.

  • Out of the 20 largest companies in Portugal, 19 are not headquartered in Portugal
  • In fact, 16 of the 20 companies mentioned above have their headquarters in countries like the Netherlands and Ireland which are considered to be the tax havens of the world

Hence, according to Gomes, these companies are earning revenue from Portugal. However, they legally escape payment of taxes by using the differential rate tax system in Europe.

Hence, wealthy European countries believe that if the European monetary union has to survive, it is important for a new fiscal union to be formed.

If the tax rates in all the Euro countries remain the same, there will be no incentive for companies to locate their headquarters in one country just to evade taxes.

Why is Harmonization a Bad Idea?

  1. Wrong Assumption: The underlying assumption below this idea is that taxation is the only source of competitive advantage. In reality that may not be the case. There are specific types of jobs which need to be moved to certain locations only. This is because these jobs require a certain kind of workforce which may not be easily available in the rural areas.

    Other factors such as the availability of better infrastructure are also very important. No firm would want to locate their factories in far off remote locations. The tax advantage would be nullified by the increased cost of transportation.

  2. Loss of Employment: When leaders from wealthy European nations refer to tax harmonization, they generally hint at increasing tax rates for countries which have lower tax rates. This would be a catastrophic decision for many small countries.

    Let’s consider the case of Ireland. During the Greek crisis in 2010, Ireland was also one of the economies that were staring at a possible bankruptcy. However, that changed very fast when Ireland dropped its tax rates.

    At the present moment, the corporate tax rate in Ireland is about 12.5%. Also, Ireland only charges about 6.25% of the income from patents and other intangible assets as taxes. As a result of these policies, Ireland has been able to reduce its debt to only 78% of the GDP. The unemployment rate in Ireland is also one of the lowest in the world.

    This is the reason why harmonization, i.e., an increase of tax rates in Ireland would be a bad idea. The Irish know this fact and hence have been opposing the harmonization. Their leaders are not willing to give up on the tax rates since they do not believe that German and French companies will set up offices in Ireland after raising tax rates. The end result would be that an increase in tax rates would cause employment in Ireland to drop.

  3. High Taxes do Not Improve Revenues: Another faulty assumption is that high taxes end up raising state revenues. Hence, the states will be able to reduce their debt, and the Euro crisis will end. Tax havens within Europe are not the only option that big corporations have if they want to evade taxes.

    There are several countries outside the Eurozone which offer favorable tax deals to corporations. Hence, even if tax harmonization is implemented, many companies will continue to evade taxes by using different tax havens.

    The bottom line is that even if the harmonization needs to take place, the tax rates should be reduced instead of being increased. The economic record is very clear.

    Countries like Ireland which have changed their tax rates saw the end of their economic problems.

    On the other hand, countries like France have never seen a balanced budget since 1980! The forcible introduction of high taxes is merely political rhetoric which is being used by politicians from high-income countries to lure voters who are scared that their jobs might be shipped to other countries.

To sum it up, there are many countries in the Eurozone, and each needs a different tax regime. If the same regime is forced upon all countries, some economies might end up being completely ruined.

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