Hey, Let's All Get Together And Raise Taxes!

Finance Ministers want to use the euro's launch to hike rates

It was scheduled as an informal meal between ideological friends. But when nine European socialist Finance Ministers assembled on the evening of Nov. 22 at the luxury Brussels Swissotel, they soon dropped the small talk to discuss an initiative that would transform the lives of Europeans. It would raise gasoline prices, discourage people from parking money in such tax havens as Luxembourg, and force countries such as Ireland to raise their corporate rates. "After coordinating our exchange rates with the euro, the next phase is to coordinate our taxes," explained the dinner host, Austrian Finance Minister Rudolf Edlinger.

The tax plan may play a key role in a larger socialist game plan of loosening public spending and imposing more political control over the new European Central Bank. If implemented, the left-wing agenda could slow or even negate the competitive forces the single currency will bring. Although business could benefit from simplifying Europe's complicated and fragmented tax laws, companies are frightened by the prospect of an increase in already high costs. "Unifying taxes is a good idea if it is downwards," says Paul Horne, chief European equity economist for Salomon Smith Barney in London. "But the socialists want to unify upwards because they don't want to cut spending."

To be sure, some of the more radical plans will likely be watered down. Tax measures require unanimous consent among the European Union's 15 members. "It's the last redoubt of national sovereignty, and governments won't give up control easily," says Lucien Thiel, president of the Luxembourg Association of Banks and Bankers. In theory, too, the euro should heighten pressure for cuts. "The euro will make clear all the differences in tax regimes," predicts Jan van der Bigl, senior tax manager for Unilever. Competition between countries could be "a tremendous counterweight" to upward tax pressure in the EU, he adds.

But it's precisely this prospect that has created a left-wing backlash. Oskar Lafontaine, Germany's new Finance Minister who made his Brussels debut at the socialist dinner party, regularly rails against "unfair" tax competition. He has made tax reform a key plank for Germany's six-month-long EU Presidency, which begins on Jan. 1.

Lafontaine's first target is corporate tax exemptions. At home, he wants to abolish preferential rates for specific industries in return for a cut in corporate taxes from 45% to 35%. The proposal would mean an overall increase in revenues. Abroad, Lafontaine is pushing a European Commission proposal to end 70 tax breaks governments use to draw investment. They range from Belgian exemptions on multinational headquarters to Spanish inducements for investors in the Basque region.

FOR STARTERS. The campaign already is forcing change. Ireland recently announced an end to its special 10% rate for new foreign manufacturing and financial investors. From 2003, all companies in Ireland must pay a 12.5% corporate tax. But Continental socialists want more. "They insist we raise our rates to their level, between 30% and 40%," says one angry Irish official. "We don't agree that everyone should have high taxes." Britain's government also is hesitant to raise its 31% tax on corporate profits. "Tax decisions will be made in Britain, not Brussels," says Chancellor of the Exchequer Gordon Brown.

Another Lafontaine goal is a compulsory 20% withholding tax on interest payments paid to nonresidents. Germans have poured money into Luxembourg and other countries that don't have any such levy. Under the new proposal, all EU governments would either have to impose the tax at the source or report the income to the recipient's home country. Luxembourg objects. And Britain, which also doesn't tax nonresident income, fears the provision could hurt the City. By raising the cost of issuing eurobonds, it could drive that business to Zurich or other financial centers outside the EU, analysts say.

No one disputes that Europe's tax system is a mess. But the main problem is the overall tax burden: Governments in most EU countries take in about half of gross domestic product in taxes compared with a third in the U.S. With deficits down and the euro on the way, Europe has a chance to cut rates. It looks set to miss the opportunity.

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