Just as I have predicted, Europe is becoming the scene of another hard fiscal battle. As a sign of how tough it is going to be, the EU is pushing hard for the right to levy its own taxes. On October 3rd, the European Court of Auditors released its “opinion”
concerning the Commission’s amended proposal for a Council Regulation on the methods and procedure for making available own resources based on the Emission Trading System, the Carbon Border Adjustment Mechanism, reallocated profits and the statistical own resource based on company profits
Under this rather convoluted headline, the Court of Auditors presents its technical analysis of what is for all intents and purposes the EU’s attempt to create a system to collect its own taxes.
Brussels no longer wants to have to rely on member states to obtain revenue.
This is a major issue for the European economy. Few matters of policy are more important right now than the attempt by the EU to build its own tax collection system. This ambitious plan is a direct threat to both the stability and the resiliency of the European economy.
As part of its ambitious revenue plan, the EU is eyeing a new tax on corporate income. According to The Irish Times, the tax rate would be 1.5% and it would theoretically apply to all of what Europeans prefer to call ‘profits’ instead of corporate income.
The paper has good news: there is strong resistance in Dublin to this tax. The opposition is directly tied to the fact that corporate income accounts for a substantial share of the country’s economy. In 2022, corporations earned 71% of the income generated by the Irish Gross Domestic Product; the Irish Times refers to the profits share of GNI, Gross National Income, which is a valid but less useful statistical concept than GDP.
Regardless of which concept one uses, the prominent role that corporate earnings play in the Irish economy is an eminent reason for the Irish government to oppose this new tax. As the Irish Times notes, an EU-specific tax on corporate income would hit Ireland harder than any other EU member state.
Brussels has many motives for wanting to create its own streams of tax revenue. At the top of the list, at least for now, is their need to refinance their debt. The EU has borrowed quite a bit of money in recent years, and the government of the European Union is now in the very same situation as the U.S. government: its cheap debt is maturing just as interest rates are high and rising.
An annual review of EU finances by the European Court of Auditors focuses on 344.3 billion euros, which the European Union owed its creditors at the end of 2022. By rough estimate, a bit more than 10% of that debt matures in the next 1-3 years; unless the EU is planning on running very large budget surpluses, it will have to replace this short-term debt with new loans.
This is no small problem for the European Union. Interest rates on euro-denominated sovereign debt have risen substantially in the past three years, far above where they were when the EU borrowed money to help its member states through the pandemic. In 2020, euro zone treasury bills came with a negative interest rate. This means that anyone who decided to lend money to any euro zone government, including the EU itself, would have to pay said government for the privilege of lending them money.
Here is how this negative rate works in practice. Suppose the EU sold €100 worth of debt in January of 2020. At that time the euro treasury bills with maturities of 1-3 years came with an average interest rate of -0.45 percent.
If the rate had been positive, i.e., 0.45 percent, whoever bought those treasury bills would have earned 45 cents per year on every €100 worth of government debt he bought. However, with the rate being negative, that same lender lost 45 cents per year from the same transaction.
The EU government, on the other hand, earned money by borrowing money. After one year, the borrowing government—including the EU—would only have to repay €99.55 for every €100 it borrowed.
Since the EU does not publicly share the details of its debt auctions, we cannot determine exactly how much they borrowed in each maturity class. Therefore, we cannot estimate their exact gains from negative interest rates. However, to come closer to the aforementioned debt figures in the Court of Auditors report, suppose the EU borrowed €30 billion at -0.45%. In one year, this debt would have been reduced by €144 million; when the lenders fork over their money, they agree to write down the debt by that much.
If the average maturity of that €30 billion debt is two years (the midpoint of the 1-to-3-year maturity span mentioned earlier), the EU makes a total of €288 million.
Suppose now that the EU has to replace the €30 billion with new loans. Today, the interest rates on euro-denominated sovereign debt maturing in 1-3 years are around 3.5%. This means that instead of making €288 million over two years, the EU must now spend €2.1 billion on interest payments to its creditors over the same period of time—for the very same amount of debt.
This is a net increase of the debt cost by more than €1.1 billion per year (including the gain from the negative interest rate). This money cannot come from other debt; you do not put your monthly mortgage payment on your credit card. Instead, the EU needs new tax revenue.
Hence the idea of “own revenue” for the European Union.
There is a plethora of arguments against EU-specific taxes, especially the corporate income tax. The European economy shows all kinds of signs of falling into a recession, and not just the ‘regular’ one that macroeconomists always talk about. This could very well be a long and deep economic downturn, where a cyclical economic downslope is mixed with self-inflicted structural economic problems like the ‘green’ energy transition.
In addition to simply raising the cost of doing business at an inopportune point in time, a new EU corporate tax would set in motion a process of economic instability and fragmentation. The reason is found in Table 1, which reports the corporate-income share of GDP (viewed from the income side):
Table 1
The three top countries in Table 1 represent three different stages of economic strength. Ireland is a favorite home for multinational corporations wishing to do business in the EU. Business investments dominate the spending side of GDP, but do so with high volatility. Unlike any other in the EU, the Irish economy violently swings between massive growth and deep economic contractions.
An EU tax on corporate income would further destabilize the Irish economy and could quite possibly rob it of future growth spurts. A permanently poorer Ireland is not in the interest of the European Union.
Romania, number two in Table 1, has a stable and relatively diversified economy. It is at the poorer end of the spectrum in the EU, but with strong growth and relatively low taxes, the government in Bucharest has lifted the country to respectable levels of prosperity. A tax on corporate income, which would hit more than 56% of the economy, could be enough to downshift the country’s currently strong trajectory of economic growth.
While Romania is unlikely to experience the same problems from this tax as Ireland will, the effects will be far from marginal. It is not in the interest of the EU to see a big, geographically crucial country like Romania in economic stagnation.
Greece ranks third on this list in large part because of the macroeconomic massacre that the country was subjected to a decade ago. This means that, unlike Romania, Greece has not earned its top spot because of a growing, resilient economy. It is there because adjusted for inflation, the average Greek household earns about as much now as it did 20 years ago. Corporate earnings, on the other hand, have to some degree returned to normalcy.
As a result of the structural imbalance between household income and corporate income, Greece runs the same economic instability risks from this tax as Ireland does.
Other European economies will take a milder hit. France already has such a costly business climate that a 1.5% extra tax on corporate income will not make much of a difference. Given that the base for this tax only accounts for 34% of their GDP, France would likely suffer the least harmful impact from this tax.
Denmark and Germany would also see limited damage, while Sweden—despite the relatively low share of corporate income in its GDP—would have to struggle to retain businesses. Their problems with keeping businesses are in large part non-economic, but if a business is going to pay this tax anyway, it might as well move out of Sweden to where social instability is not an increasingly intrusive problem.
By destabilizing some countries while sparing others, a new EU tax on corporate income would contribute to the fragmentation of the European economy. It would do so in the middle of what is shaping up to be a long, tough recession.
Another reason to oppose this tax is its part of the aforementioned package pursuing “own revenue” for the EU. As a case in point, let us return to the refinancing of EU debt. Figure 1 illustrates the yield (interest rate) trend for the benchmark 10-year euro-denominated treasury bond, since the start of this year. The same variable from the United States is thrown in for comparison, to show that the rising interest rates are not confined to Europe, nor a temporary phenomenon:
Figure 1
The blunt message in Figure 1 is that the problems that the EU currently has with financing its debt will only grow worse going forward. Therefore, if the EU can start collecting its own taxes, it is a safe bet that new taxes will follow the corporate income tax. There will be one on personal income, an EU-specific value-added tax, and a creative list of excise taxes.
All these taxes would be added to the taxes that Europeans already pay. As of the first quarter this year, they gave up 45.4% of their earnings to taxes; in the euro zone, the tax-to-GDP rate is 46.2%. If the EU gets taxation rights, these ratios will rise above 50% on average.
Individual countries where the ratio is already that high would be struggling not to tax away 60% of their economy.
But would not the EU’s own taxes replace the contributions that member states make today? Would not EU taxes simply redirect money from one government to another?
It is tempting to make this assumption. The foremost reason why this will not happen is that when the EU gains direct taxation powers—with or without its own tax collection agency—the Commission and the Parliament no longer have to rely on member states for money. That means they can significantly expand their own spending programs—and create new ones. All sorts of funds can see the light of day, be filled with money, and then used as financial vehicles for grants to favored businesses and nonprofits.
We can expect a European welfare state with union-wide minimum standards for various entitlement programs. To take one example: the EU could create its own family-oriented social benefits and use them to promote economic redistribution, abortion, and progressive alternatives to the traditional family, all in an affront to countries like Hungary where voters overwhelmingly reject such ideas.
It is a political certainty that once the EU has its own taxation powers, it will no longer be inhibited in its quest to spend more money. The EU member states are well advised to follow in Ireland’s footprints and oppose any such taxes.
