Tax policy decisions should be devolved, not harmonised across the EU

March 15, 2011 3:05 PM

Dublin has refused an offer by the European Union to reduce the interest payments on its bailout loan by almost a fifth in exchange for abandoning Ireland’s competitive 12.5 per cent corporation tax rate. French President Nicolas Sarkozy demanded a raise in the tax rate in a move towards greater EU tax ‘harmonisation’ in return for a 1 per cent cut in the 5.8 per cent interest rate on the £73.5 billion debt. But new Irish Prime Minister Enda Kenny insisted on maintaining Ireland’s flagship tax policy at the Eurozone harmonisation pact meeting.

In contrast Greece’s debt was effectively restructured with a lower interest rate and longer maturities as a reward for its deficit reduction. Markets responded by lowering Greek bond yields and pushing up Irish ones which suggests they believe a default is less likely with co-operation. This makes sense. Raising the tax rate would be likely to increase treasury revenues in the short term as well as attract the EU’s £735 million reward in the form of reduced interest charges.

So why did Dublin reject the £735 million offer and the increased tax revenues that would accrue from raising the rates?

[caption id="" align="alignright" width="252" caption="Yes or no?"][/caption]

The answer lies in the overwhelming success Ireland has enjoyed in attracting multinational firms over the past two decades and the value placed on certainty and stability. Part of the appeal of the Irish tax regime lies in the low rates but it also lies in Ireland’s commitment to maintaining them so companies can plan ahead without fear of nasty tax surprises sprung on them part way through the lifetime of an investment. If Dublin were to have accepted the EU’s offer, its attractiveness for investors would diminish not only by the extra costs the higher rate would impose on investors but also by the loss of credibility Ireland would suffer in failing to maintaining stability and low rates in its tax regime when the fiscal going gets tough.

Which of the two governments has the more sensible approach to the EU offer, Athens or Dublin? The Greek situation is different from Ireland’s, but insisting on maintaining competitive corporation tax rates in the face of huge pressure is sure to bring a significant reputational advantage to Ireland in the competition for investment and the jobs and prosperity (not to mention tax revenues) which flow from it. The short term risks, however, are clear as changes in yields illustrate. Far from harmonising policies and rates at an EU level with a one-size-fits-all approach, the best way to discover the most economically efficient tax policies and rates would be to do the opposite: devolve more decision-making from national to local levels and let competitive forces identify best practice. Attempts to standardise policies by the EU may bring some benefit by reducing compliance costs but it would remove the ability to experiment with rules at a national level which will mean any change to the rules will be applied across the Union with individual nations shielded from competitive pressures to correct a mistaken policy change.Dublin has refused an offer by the European Union to reduce the interest payments on its bailout loan by almost a fifth in exchange for abandoning Ireland’s competitive 12.5 per cent corporation tax rate. French President Nicolas Sarkozy demanded a raise in the tax rate in a move towards greater EU tax ‘harmonisation’ in return for a 1 per cent cut in the 5.8 per cent interest rate on the £73.5 billion debt. But new Irish Prime Minister Enda Kenny insisted on maintaining Ireland’s flagship tax policy at the Eurozone harmonisation pact meeting.

In contrast Greece’s debt was effectively restructured with a lower interest rate and longer maturities as a reward for its deficit reduction. Markets responded by lowering Greek bond yields and pushing up Irish ones which suggests they believe a default is less likely with co-operation. This makes sense. Raising the tax rate would be likely to increase treasury revenues in the short term as well as attract the EU’s £735 million reward in the form of reduced interest charges.

So why did Dublin reject the £735 million offer and the increased tax revenues that would accrue from raising the rates?

[caption id="" align="alignright" width="252" caption="Yes or no?"][/caption]

The answer lies in the overwhelming success Ireland has enjoyed in attracting multinational firms over the past two decades and the value placed on certainty and stability. Part of the appeal of the Irish tax regime lies in the low rates but it also lies in Ireland’s commitment to maintaining them so companies can plan ahead without fear of nasty tax surprises sprung on them part way through the lifetime of an investment. If Dublin were to have accepted the EU’s offer, its attractiveness for investors would diminish not only by the extra costs the higher rate would impose on investors but also by the loss of credibility Ireland would suffer in failing to maintaining stability and low rates in its tax regime when the fiscal going gets tough.

Which of the two governments has the more sensible approach to the EU offer, Athens or Dublin? The Greek situation is different from Ireland’s, but insisting on maintaining competitive corporation tax rates in the face of huge pressure is sure to bring a significant reputational advantage to Ireland in the competition for investment and the jobs and prosperity (not to mention tax revenues) which flow from it. The short term risks, however, are clear as changes in yields illustrate. Far from harmonising policies and rates at an EU level with a one-size-fits-all approach, the best way to discover the most economically efficient tax policies and rates would be to do the opposite: devolve more decision-making from national to local levels and let competitive forces identify best practice. Attempts to standardise policies by the EU may bring some benefit by reducing compliance costs but it would remove the ability to experiment with rules at a national level which will mean any change to the rules will be applied across the Union with individual nations shielded from competitive pressures to correct a mistaken policy change.

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