ZEW President Franz on Tax Dumping

This article appeared in the June edition of the ZEWnews.

Tax Dumping

When competition between countries grows particularly tense, we regularly see accusations of tax dumping being made, usually accompanied by calls to put a stop this kind of unfair behaviour once and for all. We like to sing the praises of economic competition, but only as long as it leaves us in peace. Where would we end up, if wages and taxes were all decided on the basis of free choice or – dare I say it – the market? This is why we have the minimum wage and minimum taxes. The latter is what is at issue here, namely the low corporation taxes in the new EU Member States. In fact, according to calculations made by ZEW, the average effective tax burden for corporate enterprises bases in these countries is 21.3 per cent, and 15.4 per cent when tax incentives for investment are taken into account. At the head of the pack is Lithuania with an average effective tax rate of 13.1 per cent and just 7.2 per cent when tax incentives are factored in. Compared to the average effective tax burden in Germany of 37.2 per cent, these countries are tax havens – and right outside Germany’s front door. However, this has nothing to do with tax dumping.

The new Member States could only be accused of tax dumping if, for instance, they were to allow foreign companies or their subsidiaries operating within their territory to benefit from investment incentives or low taxes while depriving domestic companies of these same benefits. Ireland made use of unfair practices such as these back in the 1990s – what is more against the backdrop of the country receiving financial transfers from the EU’s Structural Funds. What we should also consider are higher value added tax rates in the new Member States, such as in Hungary, where the rate is 25%. This means that these countries have chosen a slightly different tax structure in which consumption is more heavily taxed than in Germany in favour of investment. This is a legitimate, perhaps even superior, fiscal strategy.

Another interesting aspect of the current debate surrounding the supposed “tax dumping” being perpetrated by the new Member States is that these countries are the recipients of not inconsiderable financial funds from Brussels to help modernise their infrastructure. These subsidies – according to critics – made the lower corporate tax burden in these countries possible in the first place. Or, to put it in more drastic terms, we are paying them to take jobs away from Germany.

To a certain extent, such an effect cannot be totally dismissed. It is not the fiscal policy in these countries that we should be levelling criticism at, but rather the EU’s infrastructure aid programme, which is currently welcomed with open arms here in Germany, as long as regions in East Germany are the beneficiaries. Politicians knew exactly what they were doing when they signed the accession treaties. It’s rather late to complain now. Therefore, as far as possible, EU infrastructure aid should be reviewed and, where necessary, cut back.

There is no way that Germany and its high tax burden can avoid entering into the international tax competition. The need for this became clear well before 1 May 2004, since Germany compares just as unfavourably to the older EU Member States in terms of corporate tax burden, even when the most recent tax reform being implemented next year is taken into consideration. Fears of ruinous tax competition – a “race to the bottom” – are largely unfounded. Companies are also interested in high quality business locations and are prepared to pay higher taxes to operate there.