The Brussels Tax Forum

Le Forum Fiscal de Bruxelles

Das Brüsseler Steuerforum

Minutes of the 2nd BRUSSELS TAX FORUM

Taxation policy: Enhancing competitiveness

and growth in a European way The second Brussels Tax Forum was held in Brussels, on 7th and 8th April 2008. The topic of this year's Tax forum was Taxation policy: Enhancing competitiveness and growth in a European way. The Brussels Tax Forum attracted around 600 participants from 38 countries.

2

Monday 7th April 2008: Opening Session

The Opening Ceremony was headed by the Commissioner for Taxation and Customs Union, Mr László Kovács who welcomed the speakers and participants. Starting from the challenges that Europe is currently facing, namely globalisation and ageing population, he pointed out to their fiscal consequences. The need for pro-growth tax systems, which would make work desirable and increase competitiveness, was stressed.

Commissioner Kovács underlined the role of the EU Lisbon agenda for achieving growth, as well as an increase in jobs and competitiveness. The Commissioner addressed the role of taxation in the economic performance of Member States and pointed out to the theoretical and empirical results. Finally, the actions of the European Commission in the field of both, indirect and direct taxes, was highlighted in his opening speech.

Mrs Pervenche Berès, Chairwoman of the European Parliament's Committee on Economic and Monetary Affairs, addresses in her opening speech the need for an increased coordination and for elimination of tax obstacles. A number of issues were identified to have an impact on competitiveness: globalisation, corporate tax competition, tax treatments of SMEs and protection of environment.

MEP Berès welcomed the Commission's proposal for the CCCTB, which was found to be an ambitious project and the best solution to the taxation of trans-border transactions within EU.

3

Mrs Christine Lagarde, French Minister for Economic Affairs, Industry and Employment, has highlighted the most recent changes in the French tax system and indicated the tax-related priorities during the coming French presidency, e.g. the VAT treatment of the environmental-friendly goods and the CCCTB.

Minister Lagarde, has called for an intelligent tax, which should, in

particular, be simple and predictable; be able to increase the country's competitiveness; contribute to the sustainable development and be consistent with EU regulations.

Mr Günther Verheugen, Vice-President of the European Commission and the Commissioner for Enterprise and Industry, has closed the opening session. He stressed in his speech the fact that the EU objective to become the most competitive economy in the world is a priority for this Commission. The relation of the competitiveness and taxation and the quality of public spending was emphasized.

Vice-President Verheugen called for a comprehensive and stable tax system, which should give incentives for competitiveness and growth.

4

Monday 7th April 2008: afternoon session

The role of taxation in enhancing growth and competitiveness

The next session was titled the role of taxation in enhancing growth and competitiveness and was chaired by Professor Christa Randzio-Plath, University of Hamburg.

Professor Peter Birch Sørensen, University of Copenhagen, gave a presentation on an economic assessment of the relation between taxation and growth. It was shown that the empirical data do not indicate an apparent link between the overall taxation (measured as an average tax rate) and the long-term economic growth rate. The main sources of growth were defined to be capital accumulation, labour supply and productivity growth, on which taxation may have an impact. The favourable tax treatment for SMEs was questioned because of a lack of economic rationale.

Mr Andrej Bajuk, President of EU ECOFIN and Slovenian Minister of Finance, has defined taxation as a core instrument for EU Internal Market. The impact of tax reforms and social spending on the economic welfare has been indicated. Minister Bajuk signalled the importance of the link between taxation and labour participation, protection of environment, tax fraud and the level of research and development.

Minister Bajuk has recalled the actions and the engagement made during the Slovenian presidency, e.g. in the field of combating VAT fraud.

5

The two speeches were followed by a panel discussion chaired by Professor Christa Randzio-Plath and with the participation of Mr. Michel Aujean (Taj Law firm and former Director of Tax Policy TAXUD), Mr. Philippe de Buck (Secretary General of Business Europe), Dr. Jeffrey Owens (Director of the OECD Centre on Tax Policy and Administration), Ms. Maria Lourdes Pérez-Luque (Salans and President of the Confédération Fiscale Européenne) and Professor Peter Birch Sørensen (University of Copenhagen).

The panel discussion showed that there is a general consensus on the need for a sound tax competition, which could be achieved by allowing a simple and predictable tax system. Mr Aujean expressed the view that CCCTB is a tool for promoting sound tax competition.

Mr de Buck stressed the importance of eliminating unnecessary compliance costs for companies with cross-border activities.

Ms. Maria Lourdes Pérez-Luque mentioned that the tax system may often influence the company's investment decision but is by far not the only decisive factor. Total administrative burden, labour taxation and social security contributions as well as stability of the tax system might appear even more important while making investment decision.

6

Dr. Jeffrey Owens confirmed that the whole tax system should be analysed in order to evaluate its pro-growth and competitive character. He stated that a pro-growth theoretical tax system could include the following elements: none or low broad-base CIT, flat PIT, broadbased VAT and business-friendly environmental tax. He stressed the importance of the trade-off between the efficiency, equity and simplicity of the tax system.

Professor Peter Birch Sørensen draw the attention to the fact that the example of the Nordic countries show that the choice and quality of the public spending might offset the negative impact of taxation and contribute to growth and competitiveness. He also mentioned that direct subsidies to research and development are more efficient and outdo the benefits of tax incentives in this field. Professor Christa Randzio-Plath closed the discussion summarising the main points raised during the debate.

7

Monday 8th April 2008: morning session

Which fundamental tax reforms for growth and competitiveness in Europe to meet the challenges of a globalised world?

The morning session on Tuesday dealt with the question which fundamental tax reforms could foster growth and competitiveness in Europe to meet the challenges of a globalised world. The Director-General of DG TAXUD, Robert Verrue, chaired the session which was divided into two parts: the talks of experts on different types of tax reform and a panel discussion between experts and audience moderated by Ms. Jacki Davis, Communications Director at the European Policy Centre.

The session started off with Mr. Etienne Davignon, Vice-President Suez-Tractebel and former Vice-President of the European Union, who focused on the question "Which tax reforms are desirable for growth in Europe?" He pointed out that the Lisbon strategy was about structural reforms in Europe but that especially fiscal policy was still mainly a

national competence. He explained how important a European multilateral approach in certain fields of taxation was by giving three examples of unresolved tax policy issues. Firstly, Mr. Davignon discussed the introduction of a Common Consolidated Corporate Tax Base (CCCTB). He argued that having 27 Member States with 27 different fiscal systems for company taxation was an obstacle to the functioning of the single market in Europe. The problems of transfer pricing, compliance costs and the treatment of international losses could be solved with the CCCTB. Mr. Davignon pointed out that even if the CCCTB is not perfect, it would be a substantial improvement and it would promote growth: "It is better to have one system that we do not like than 100 that do not work". Secondly, he mentioned the double taxation of dividends in the European Union and concluded that the current regulations still led to double taxation within the EU. This affected individuals and investors, generating a negative effect on competitiveness and growth in the EU. Finally, he discussed was the taxation of labour in a European context.

8

Mr. Davignon explained that there was labour mobility in international companies but that this mobility was still relatively low in the EU. One of the reasons he gave for this unsatisfactory mobility was the fact that there is no clearing for social security contributions paid by an employee between Member States and still too many uncertainties on the tax status of posted workers. As Mr. Davignon argued, these three examples underlined there was no reason not to act, but that there is the need for multilateral action on a European level to reduce the costs of different tax obstacles for companies and citizens within the EU.

After some general thoughts on taxation matters in Europe, Professor Clemens Fuest from the University of Cologne and the University of Oxford analysed one possible reform of taxation asking "Shall we shift taxation from labour to consumption?" The main reason to shift from labour to consumption taxes was the strong increase in the taxation of labour that came along with an increase in unemployment in Europe, as Professor Fuest explained. Accordingly, a reduction of the tax wedge on labour was a key policy objective for many EU Member

States. The main conclusions from his presentation showed that the financing of a reduction in labour taxes through higher taxes on goods and services (VAT) would neutralize some but not all positive effects on employment and growth from the labour tax reduction. However, the overall magnitude of the employment and growth effects that could be expected was limited. Furthermore, Professor Fuest underlined that such a reform was likely to be slightly regressive and that employees benefit most at medium and higher income levels which also meant that work incentives were improved for this group. However, the (direct and indirect) tax burden on low income households might increase. This could be a problem of this reform proposal since the share of unemployed is usually large in the low income worker group. A higher tax burden for this group due to a reform might reduce the employment opportunities for this group even stronger.

The story of a successful tax reform that took place in Estonia in 1994 with the introduction of a flat tax was presented by Mart Laar, Member of the Estonian parliament and former Prime Minister of Estonia in his speech on "Flat tax and growth: the Estonian experience." He argued that five points had been of importance for Estonians transition to market economy: Monetary reform, open economy, rules of law, privatization and what he called the "tax revolution", namely the introduction of a flat tax. Prime Minister Laar argued that the advantages of a flat tax on income were the cheap tax collection, the positive work incentives, the encouragement of economic activity and the fact that the grey sector of the economy had reduced significantly. With respect to the connection between growth and the flat tax, Prime Minister Laar showed his conviction that the tax

9

had a very positive influence on the Estonian economic performance. He recommended the flat tax as a promising option.

The flat tax was also the subject of Michael Keen's talk "Flat taxes: what have they achieved?". Dr. Keen who is an advisor to the International Monetary Fund presented the results of empirical studies on flat taxes. He underlined that there is an important difference between the definitions of the term "flat tax" in North America and in the

policy debate in Europe. The definition for the European debate is that a flat tax is a tax with a single marginal rate on labour income. Flat taxes are now used in a number of countries (Estonia, Lithuania, Latvia, and Russia among them). He evaluated the flat tax in terms of equity, incentives and simplicity and compliance. With respect to equity a flat tax is a progressive tax as long as there is some kind of threshold. A reduction of tax

burden when substituting a progressive income tax by a flat tax can usually be seen for very low and very high incomes while the income in the middle range pays more taxes. Empirical studies following the introduction of a flat tax in Russia did not show any evidence that there are positive or negative effects on the incentives for labour supply or the tax payment of households. For the simplicity and compliance, Dr. Keen pointed out that at least for the Russian data an improvement of compliance is measurable. But this might also be attributed to administrative changes as a flat tax reform often goes along with a substantial clearing of exemptions. The conclusion of Dr. Keen's talk was that empirical research found no strong impact of the flat tax on labour supply or taxable income. In his view the introduction of the flat tax could also be interpreted as a signal in an international competitive setting which shows that a country changes towards a market economy and that this might be a reason for investment and growth rather than the flat tax itself.

After the debate on the flat tax, William H. Morris, Director European Tax Policy, General Electric and Amcham, shared his thoughts on the question if business benefits from an EU wide tax base. He indicated if a CCCTB allowed for consolidation of group income across borders that this would allow an intra-EU loss relief and also end intra-EU transfer pricing disputes. As the same tax base calculation rules would be introduced across borders, this should also help simplification. The measures on tax administration suggested by the Commission would also cut compliance costs in his opinion. Mr. Morris pointed out that even if there some disadvantages for business as companies would lose some beneficial regimes in individual countries the CCCTB could be beneficial to businesses both large and small. However, if the key features of optionality, consolidation, and administrative simplicity were traded away by the

10

Member States during the implementation the CCCTB could also harm the attractiveness of the EU as a location for foreign investment and the competitiveness of EU-based companies and groups

After this set of presentations the audience had the chance to join the discussion with the experts. The key topic dealt with the question if the simplicity of a tax is a value itself. Professor Clemens Fuest pointed out that simplicity was good, if it was costless but that tax systems had many different functions which were not covered when using the simplest tax available. Mr. William H. Morris added that simplicity is indeed not always reachable but that it is necessary to actively avoid adding complexity to existing systems. Another important aspect of the discussion was that there might be a need for a discussion between the EU and the Member States on the current situation of taxation in the Union. Speakers indicated there might be two perspectives: On the one hand the EU is viewing tax policy as a means to further improve the functioning of the single market while for many Member States tax policy mainly deals with raising tax revenue in a nationally efficient way.

The morning session ended with a talk by Dr. Christopher Heady, Head of Tax Policy Division, Centre for Tax Policy and Administration, OECD, dealing with the key issue of the session "Which fundamental tax reforms in Europe in a tax competition environment?" In order to answer this question the OECD carried out an empirical research project. The goal of the project was to analyse if certain tax structures rather than the

ratio of tax revenues to GDP could find a relation between the tax mix and growth. The findings of this study suggest that the pressures of tax competition may lead to a tax mix that is better for growth. Such a tax mix would encompass a shift towards more consumption and property taxes and fewer income taxes. However, this could well lead to greater inequality Dr. Heady concluded, even though taxes on immovable property are a potential exception. Nevertheless, these suggestions should be put into perspective of each country's tax system.

11

Monday 8th April 2008: afternoon session

How to finance the Welfare State in Europe: threats and challenges

The afternoon session of the second day, chaired by Mr. Karel Lannoo, CEO of CEPS, started with the presentation of Vladimír Spidla, Commissioner for Employment, Social Affairs and Equal Opportunities.

Commissioner Spidla stressed that a reform of the welfare state in Europe is necessary in order to maintain its financial sustainability in the conditions of globalisation and ageing population. In particular, the tax/ benefit systems should be modernised so that EU

economies could maximally benefit from globalisation. In this regard it is essential not to tax too heavily low-income earners and adjust the benefit systems in such a way that they don't create disincentives to work (unemployment traps). He said that many EU Member States have already gone to this direction, but there is still scope to reduce the tax burden on labour in many of them. All the Member States should aim at a

tax/benefit system, which is based on solidarity, justice and economic efficiency. The Commissioner concluded by saying that to make progress in tax policy the open method of coordination could be used more at the EU level than has been the case so far.

The second presentation, made by Dr. Jaakko Kiander from the Finnish Labour Institute of Economic Research, was titled "Are high taxes and high social benefits and obstacle to a competitive economy?" His presentation focused on the experience of the Nordic countries, which have been able to combine good economic performance in the last decade with high taxation and a large public sector. Hence, contrary to the basic tenets of economic theory, the answer to the question of the title seems to be "no" in the light of the Nordic experience. Which factors have contributed to the success of the Nordic economies? Dr. Kiander stressed first that since there are enough common features in the Nordic economies, it is possible to speak about the Nordic model. These factors are relatively numerous and well known, such as egalitarian income distribution,

12

high level of education, innovation, R&D etc. In his presentation he focused on the aspects of tax/ benefit systems that seem to characterise all the Nordic economies. First, social benefits are earning-related and thus provide incentives for labour force participation, the same as active labour market policies. Tax bases are large with not many deductions. Hence, the actual tax rates facing wage-earners are not high in relative terms, even if gross tax rates are high. Corporate income tax rates are at the competitive level, since the introduction of dual income tax system in the 90s in all the Nordic countries. Large part of tax revenues are raised by broad based consumption taxes (VAT and green taxes). Finally, high taxes are needed to finance public services, which are appreciated by the population and thus make high level of taxation acceptable, and also provide a large number of jobs to female labour force.

Professor Hans-Werner Sinn, IFO Institute for Economic Research and University of Munich, addressed the topic "Do countries compete over tax and welfare systems, and if so, how?" In his presentation he referred his book "The new systems competition", published in 2003. He stressed that the four basic liberties in the EU (goods, people,

services, capital) create the situation where countries necessarily compete for the location of activities. In doing so, i.e. in trying to correct market failures, the competition of governments itself may suffer from market failure. Currently the countries compete for mobile capital, which have led to the rapid fall of CIT rates in Europe. This implies the race-to-the bottom of CIT rates, the bottom being not zero, however, but the

marginal cost of hosting foreign capital. In this sense the taxes turn more and more to benefit taxes that are sufficient to finance only infrastructure investments, but not the welfare system. Tax harmonisation at the EU level would be a remedy, but difficult to achieve under current EU decision-making rules. Another form of systems competition is regulatory competition, or competition of laxity. The governments tend to lower the standards of regulation, when they compete for foreign activities. Banking regulation is the case in point, as the recent event of German tax fraud related to Lichtenstein reveals. To solve this problem international agreements are necessary (e.g. Basel II, Codes of Conduct by EU /OECD etc.). The third form of systems competition is referred to as welfare competition. It is caused by the free mobility of people and different levels of wages and welfare benefits between countries. People tend to move to the countries with the highest levels of benefits, if these benefits are freely available to all in the name of inclusion principle. This will lead to the gradual erosion of the welfare state according to the speaker. The remedy in this case is not to remove the welfare state, nor to restrict the

13

free mobility of labour, but to give up the inclusion principle, which according to the speaker is not a big sacrifice after all. It would imply that, for instance, that the home-country principle of welfare benefits would be applied to non-employed EU citizens for a period of time, but those with a refugee status could still be entitled to the welfare system.

Dr. Joakim Palme from the Institute of Future Studies in Stockholm spoke about the tax/benefit systems and labour force participation of women. He stressed that maintaining the high level of labour supply is essential for the sustainability if the European Social Model in the face ageing society (it is better to have more tax-payers than higher taxes) and for that reason, it is essential that the society supports the labour force participation of women and that there are sufficient work incentives in the tax/ benefit systems. These are created, for instance, by separate taxation of spouses and earning-related benefit schemes. According to the speaker there are different models of family support in the EU Member States. Market-oriented models are typical of Anglo-Saxon countries, traditional cash- based models characterise Central European countries, while the dual-earner model prevails in the Nordic countries. Comparison of statistical data of the EU countries reveals that the dual-earner model is associated with the higher levels of employment, but also, paradoxically, with the higher rates of fertility and the lower level of child poverty that the two other models. These models do not exist anymore, however, in pure forms, but have more mixed nature in most countries. The speaker concludes that the design of tax/benefit systems affects social policy outcomes and is also instrumental to the sustainability of the welfare system by affecting the number of tax payers. Incentives, resources, opportunities and the supply of welfare services all play a role.

John Monks, General Secretary of the European Trade Union Confederation, commented several topics related to the presentation made in the conference. These included the flexicurity model of the labour market characterising the Nordic countries, which works well in these countries but is expensive to implement, the importance of affordable child care, which is lacking in many countries, tax concessions accorded to wealthy

foreign employees in many countries, which generate several problems, as well as flat taxes, which are not necessarily the sole explanation for fast growth in flat tax countries

14

and not necessarily instrumental in reducing tax fraud according to the speaker. He concluded by saying that there are no easy answers on how the design a good tax system because of conflicting goals. A few interesting ideas have appeared, however, which are worth considering further. These include shifting tax burden from labour to consumption, widening international agreements on tax havens and achieving the EU wide agreement on corporate tax levels, which could usefully complement the EMU.

Commissioner László Kovács has closed the conference. Mr Kovács has stressed the importance and relevance of the topic and assured that the discussions will greatly assist the Commission in the policy-making process. In particular, Mr Kovács has pointed out the need to eliminate administrative and tax-related barriers in order to allow for a fair tax competition. The Commissioner concluded from the discussions that the proposal by the Commission for a common consolidated corporate tax base (CCCTB) is supported by a number of Member States, by the European Parliament and awaited by the European business community. Mr Kovács underlined the Commission’s intention to keep Commission’s proposals for CCCTB and VAT one-stop shop as simple, broad and transparent as possible.

Finally, Mr Kovács has stressed high quality of the political and scientific content of all the sessions and thanked all the participants and audience for the fruitful discussion.