REPORT on the impact of national tax reforms on the EU economy
EP Committee on Economic and Monetary Affairs
MEP Markus Ferber
The Treaty of the Functioning of the European Union (TFEU) gives the Member States the sovereign right to decide on their taxation policy but obliges them to respect EU norms. At the same time, the tax policy choices made by Member States have obvious consequences for the functioning of the Single Market. A certain degree of policy coordination is therefore desirable in order to prevent problems such legal uncertainty, red-tape, risk of double taxation and difficulties claiming tax refunds, all of which can ultimately dissuade companies and citizens from engaging in cross-border economic activity. At the same time, tax policy fragmentation combined with a lack of cooperation of tax authorities might facilitate arbitrage possibilities and aggressive tax planning.
Impact on Small and Medium Enterprises:
The detriments of tax policy fragmentation as well as the potential benefits of better coordination of national tax policies are unevenly distributed among different economic actors, with Small and Medium Enterprises (SME) suffering the most. Tax compliance costs do not fully scale with an enterprise’s overall growth and are therefore significantly more noticeable for smaller companies than for larger ones. Some Member States attempt to compensate SMEs for the challenges they face in relation to higher tax compliance costs by setting up favourable tax regimes for smaller companies. While support to SMEs is generally welcome, such measures come with a certain risk of introducing new distortions, e.g. by incentivising companies to stay small. Therefore, the benefits of such preferential regimes need to be carefully weighed against potential downsides. Another option to facilitate cross-border economic activity would be to harmonise the tax base as intended in the Commission proposal for a common (consolidated) corporate tax base (C(C)CTB)) as well as the upcoming Commission initiative ‘BEFIT – Business in Europe: Framework for Income Taxation’.
Coordination of Tax Policy
While there is a need for tax policy coordination across the EU, the European Union has primarily soft law instruments available to establish tax policy coordination, the most important ones being the Code of Conduct Group for Business Taxation, country-specific recommendations in the context of the European Semester as well as legislative procedure subject to unanimity voting in the Council. While the European Union’s toolkit is somewhat limited, the ideal level for tax policy coordination is the global level. If history is a guide, policy proposals emanating from OECD discussions often have a higher likelihood of actually being adopted in the Council and come with the benefit of reducing tax policy fragmentation even beyond the Single Market. This in turn is particularly beneficial for SMEs that aim to enlarge their potential market even beyond European borders.
Recommendation/Areas for Reforms
While there is ample room for improvements in relation to more effective EU tax policy coordination, the report concentrates on a few key areas where reforms both necessary and realistic.
The corporate tax systems in most Member States are set up in a way that they allow for generous tax deductions of debt-servicing costs, while having no similar mechanism to deduct equity financing costs thus making debt-financing comparatively more attractive than equity financing. The different tax treatment of different financing channels might incentivise companies to overleverage making them less resilient in adverse economic scenarios. Furthermore, this debt-equity bias constitutes a structural disadvantage for young and small companies that have to rely more heavily on equity financing. In order to counter that problem, some Member States have introduced an allowance for corporate equity, yet a European approach would be more sensible in order to avoid distortions across the Single Market.
Effective Marginal Tax Rate (EMTR) Competition
The effective marginal corporate tax rate is a factor that can heavily influence corporate investment decisions, e.g. when choosing a location for a new operation. Hence, Member States sometimes compete for business via lowering the effective marginal corporate tax rate. Therefore, the variation in effective marginal corporate tax rates across Member States is significantly higher than the variation in statutory rates with the forward-looking EMTR in some Member States even being negative in 2020. Hence, this metric would be worthwhile for the European Commission to look at in order to determine whether some Member States are distorting competition by artificially lowering marginal rates, e.g. by introducing accelerated depreciation schedules or granting too generous deductibility possibilities.
Tax Incentives for Research and Development
Research and development spending comes with obvious benefits for society and the economy as it encourages innovation and ultimately results in falling prices and more competition. Nonetheless, the overall research and development expenditure as a percentage of gross domestic product is considerably lower in the EU than it is in other advanced economies. In order to counter this, many Member States attempt to stimulate additional investments in research and development by providing tax incentives. However, there are doubts if all tax incentives in this area are equally effective. IP box and patent box regimes in particular have historically done little to boost additional research and development spending, but have on the contrary introduced new distortions to the Single Market. A joint understanding of Member States how to handle tax incentives for research and development would therefore be worthwhile. The Commission’s attempt to introduce a common framework for research and development spending as part of the Common Corporate Tax Base should therefore be revisited.
EU Taxation Scoreboard
The European Commission has signalled its intention to work on an EU Taxation Scoreboard in order to better detect Member States’ tax policies that could facilitate aggressive tax planning and threaten the Single Market. The European Commission is invited to inform the European Parliament about the state of play of its planning and to take into consideration the input provided by the European Parliament on the matter.
Source and full version: REPORT on the impact of national tax reforms on the EU economy – A9-0348/2021