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Europe without fiscal frontiers: An assessment
Europearr Managemerrt lournal Volume 6 No 4 0 Europearl Mnrlapnent journal 1988 lSSN U263-2373 $3.00
Europe Without Fiscal Frontiers: An Assessment John Kay Professor of Industrial
Policy and Director,
Centre for Business Strategy,
London Business School
Proposals for approximating and harmonising indirect taxes across Europe are central to the planned creation of a single European market in 1992. If implemented, the Commission’s proposals would have major direct and indirect effects for a wide variety of European business. They would also have very large effects on the revenue position, tax structures, and tax administrations of member states. For this reason, they are very unlikely to be implemented, and since partial harmonisation is no more possible than partial pregnancy, it follows that the realistic prospect of fiscal frontiers being dismantled in 1992, or in any forseeable time frame, is small. It is important that business planning should be based, not on loose generalisations about the coming single European market, but on a careful assessment of what changes are likely to be implemented in practice.
effects on firms whose market prospects are substantially influenced by tax or trade distortions (e.g. duty free services, VAT exempt activities).
Introduction
l
The European Commission has, as is well known, put forward a range of proposals for creating a single internal market within the European Community by the end of 1992 (European Commission, 1985). Much attention has been given to the possible managerial implications of such a development but comparatively little to the implications of proposals themselves. This paper examines these proposals in one, central, area: that of fiscal policy. These are explained in relative detail in Corn 1871 320.
This paper begins by identifying these effects. Once this is done, however, it quickly becomes apparent that the probability of their implementation in the firm presently proposed by the Commission or anything resembling it is negligible. The agenda that follows is then a somewhat different one.
Implementation of the 1992 plans would affect firms in a variety of ways. Ordered from the general to the specific, they include: major effects on the fiscal position of member states with resultant implications for the level of other (principally direct) taxes the facilitation of cross border trade, and sourcing as a result of reduced costs of border formalities greater cross border shopping by individuals effects on firms whose market prospects are substantially influenced by tax levels (e.g. drink and tobacco)
Are the fiscal proposals genuinely central to the 1992 project? l What are the options likely to be adopted in practice? l Can 1992 happen? l
The answers to these questions are central to any understanding or analysis of what the internal market means in practice.
What does the Commission
propose?
The fiscal package for 1992 has been described as “convergence by reference to points of departure
EUROPE
rather than points of arrival”. This means that the Commission has not asked the question “what would be the best tax structure for the Community as a whole?” Instead, it has sought to put forward a regime which, particularly in rate structure, represents an average of existing positions. Thus “it must be clearly understood that the present package is not an attempt to design an ideal fiscal system for the Community but a blueprint for the abolition of fiscal frontiers . (The Commission has) confined itself to setting out the minimum changes which must be made to . . achieve a sufficient degree of fiscal approximation” (Corn [87] 320). The plans for fiscal harmonization contained in the Commission’s proposal for completing the internal market relate only to indirect taxes. There are no immediate plans to promote further convergence of direct taxes - such as income tax, social security colltributions, or corporation tax - although these The ha,. t’ been the subject of separate discussion. taxes of principal concern are VAT - levied in all member states of the Community - and excise duties imposed on particular commodities, especially alcollolic drinks, tobacco products, and major fuels. The range of VAT rates currently charged in EC member states is shown in Table 1. The standard rate varies from 12% (Luxembourg, Spain) to 22% (Dtnnmark). The number of rates ranges from one in Denmark - which applies a flat 22% rate to almost all commodities - to seven in France. Before the the Commission had not prt sent 1992 campaign, bet-n seriously concerned to promote greater uniformity in rate structures. The Sixth Directive on some VAT, published in 1977, has encouraged con\‘ergence on the tax base. Most countries exempt he
Belk4um D&:mark Frailse Germany G rei*se IlX?l.lild Ital;,
Lu
2.1 - 13 6 0, 10 2, 9 3, 6 6
19
25, 33 334 36 _
18 12
38 _
16
30
12 15
33 -
22 18.6 l-1 1s 2s
WITHOUT
FISCAL
FRONTIERS
339
major technical problems in devising a satisfactory VAT regime - financial services and housing. Financial services are, in the main, exempt, and in most countries (although not the UK) new residential construction is taxed and rents are exempt from VAT. The scheme put forward by the Commission would require each country to adopt a common rate structure with a standard and a reduced rate. The plan does not insist on complete harmonization: each state would be free to choose a higher rate in the range 14%-19% and a lower rate in the range 4%-9%. There would, however, be complete convergence on the base. Current exemptions Ivould The lower rate would apply to mostly remain. foodstuffs, fuel, water supplies, medicines, books, and periodicals, and public transport. newspapers, All other goods and services would then be subject to the standard rate. The normal mechanism by which VAT is collected is that tax is chargeable on the whole of the output of a registered trader. If the purchaser is another registered trader in the same country, he can reclaim the VAT paid against his own potential liability. to another EEC country or Exports - whether elsewhere - are zero rated for VAT, however, so that they may be excluded from taxable output. Traders classify output themselves, but they may be required to provide evidence - including documentation of border controls - in produced for purposes support of their claim that tax is not payable on a particular exported portion of their output. When the goods are imported into another country which levies VAT (including all EEC states) tax is payable by the importer when the goods cross the frontier. In practice, the goods can normally be brought into the country against a guarantee of payment. Under the Commission’s proposals, exports to other member states would no longer be zero rated, and registered traders in other EEC countries would be treated as traders within the same country are now. Thus if a German firm buys materials from an Italian producer, it now reclaims the VAT paid (at German rates) by the German importer, or pays such VAT itself and offsets it against tax payable on its own output. In future, it would reclaim the VAT paid (at Italian rates) by the Italian exporter. A side effect - of this change - but a critical one - is that the VAT which was formerly paid in Germany, and repaid in Germany, would no\\’ be paid in Italy and repaid in Germany. Until Europe is a great deal more united than it is now, this outcome is not likely to be congenial to the German government. The EEC would therefore establish a clearing house in which
340
JOHN KAY Italian producer
all payments were redistributed to their country of origin. Figure 1 illustrates the current procedure which distinguishes the claim of transactions by the place of residence of the purchaser. Figure 2 illustrates the position after 1992, in which the two claims appear identical to the producer, and a side transaction takes place by means of the clearing house. Most EC member states impose substantial excise duties on alcoholic drinks, tobacco, and petrol. There are, however, massive differences in the tax structures adopted and in rates of tax. There are three principal categories of alcoholic drink - spirits wines and beer. Northern European countries tend to tax all drinks more heavily and wine producing states tax wine lightly, if at all (Table 2). Taxation of spirits and beer is normally related to the alcoholic strength of the product, that of wine based on the volume. The Commission’s proposals represent an arithmetic average of the existing levels of these taxes. Tobacco is subject to two types of tax (in addition to VAT) - a specific duty, chargeable per cigarette, and an ad valorem tax, based on the price of the cigarettes. There are considerable variations in the level and structure of these taxes across countries (Table 3). Ag am, what is proposed is that all states should levy tax at the (unweighted) average rate of individual countries.
-
National
border
ri
Italian purchaser
I
I
German purchaser
I
J Italian purchase1
Italian VAT reclnimcd
German purchaser
Italian VAT reclaimed
EUROPE
Table 2 Taxation of alcoholic drink in the EEC (rate in ECU at April 1986) Spirits’
Bee?
Win2
Denmark Ireland UK Netherlands Belglum Germany France Luxembourg Spain Portugal Italy Greece
10.5 8.17 7.45 3.80 3.76 3.52 3.45 2.53 0.93 0.74 0.69 0.14
1.57 2.79 1.54 0.34 0.33 0.03 0.13 -
0.71 1.13 0.68 0.23 0.13 0.07 0.03 0.06 0.03 0.09 0.17 0.10
EC proposal
3.81
0.17
0.17
* per 0.75 litre bottle, standard strength 2 per litre 3 per litre, 1050 original gravity SOIULi.
Table 3 Tax&ion April 1986)
WITHOUT
of cigarettes
Specific tax
Denmark Ireland UK Germany Netherlands Belgium Italy Luxembourg France Portugal Greece Spain
1.52 1.00 0.96 0.52 0.24 0.05 0.03 0.03 0.03 0.04 0.01 0.01
EC proposal
0.39
FISCAL FRONTIERS
341
in the EEC’ (rate in ECU at
Ad valorem Cux (%, inch VAT) 39 35 34 44 54 66 69 64 71 63 58 35
Tax per packet
2.76 1.88 1.76 1.29 0.97 0.87 0.73 0.51 0.51 0.50 0.26 0.12
52-54
’ for cigarettes in the most popular price category (this tends to be relatively cheaper for the countries lower in the table). Source: European Commission
European Commission
Diesel fuel - used mostly, but not exclusively, by commercial hauliers - is everywhere taxed more lightly than petrol - used mostly, but not exclusively, by private motorists. Averaging of the tax rates would lead to a tax on petrol roughly twice the level imposed on derv (Table 4).
Because the rates of tax on all these commodities alcohol, tobacco, petrol - are high, the risks of tax evasion are considerable and all countries adopt reasonably rigorous controls in an attempt to reduce its incidence. rhese controls are of two principal types - registration of premises and physical marking of commodities. A factory in which a dutiable product is made, or a warehouse in which it is stored, must be registered with the revenue authorities. The goods in question may then be transferred to some other registered establishment, or exported, under close supervision. If they are is removed from the premises for any other purpose, duty becomes payable. The second mechanism involves commodity marking. In Britain, for example, refined oil products whit,h are not for sale as petrol (and are therefore subject to a lower rate of duty) are dyed so that improper use can be readily detected. In France, wintx must be stamped as duty paid before it is bottled, and in several EEC countries, tax stamps or “bar,deroles” must be affixed to packets of cigarettes. Possession of unmarked goods by someone other than an authorised trader then becomes prima facie evidence of tax fraud.
The Commission’s proposals for excise duty harmonization would rely on registration of premises. Goods would move under seal and supervision between registered premises in different parts of the Community, but when they left such premises (other than for export from the Community) duty would be payable. With a single rate of tax applying within the Community, duty paid goods could then move freely between countries. Since it is not proposed that the clearing house will apply to excises, it would appear that duty would accrue to those states in which production or storage facilities happened to be located.
The Implications The effect on business of these changes, if implemented, would be of two kinds. There are effects which result from the changes in rates, and there are effects consequent on the approximation or harmonization of taxes and tax structures across the community. The direct effect of rate changes are principally of concern to a limited group of industries, although of massive concern to them. The most obvious impacts are on: l l l
alcoholic drink producers and retailers cigarette manufacturers and retailers petrol wholesalers
342
JOHN KAY
4 Taxation of motor fuel ECU at April 7986)
Table
Source:
in the EE (rate per litre in
Table 5 (ECU)
Average
Petrol
Derv
Country
Italy Denmark Greece Portugal France Ireland UK Netherlands Belgium Germany Luxembourg Spain
0.53 0.46 0.42 0.41 0.39 0.38 0.31 0.29 0.25 0.24 0.20 0.20
0.12 0.19 0.12 0.18 0.19 0.29 0.26 0.08 0.12 0.20 0.10 0.03
Belgium France Germany Italy Netherlands United Kingdom
EC proposal
0.34
0.18
Source:
European Commission
There will also producer:
be effects
on other
categories
of
gainers or losers from harmonization in the rate base (e.g. producers of certain foodstuffs) l industries subject to minor excise duties (e.g. German distributors of coffee and tea) l firms and industries benefitting from duty free trading (e.g. producers of major international brands, ferries, airports) l
l industries l
exempt
industries affected individuals
relevance from
harmonized
VAT shopping
34 87 79 205 50 49 Table 2.2
The effects on national tax structures and government revenues will certainly be as substantial as the effects on business. The implications of the changes in tax systems are major. They include: the termination of zero rating under VAT in Ireland and the UK the introduction of wine taxation in Germany, France, Italy, Portugal and Spain a reduction in taxes on alcohol in Denmark of around 60% for spirits, 90% for wine and 75% for beer the halving of tobacco taxation in Ireland the doubling of cigarette prices in Greece The overall fiscal impact on the budget member states is considerable (Table 6).
by
More wide ranging effects on all firms which do, or might, trade throughout an integrated market will come from the lowers costs and greater flexibility associted with the absence of fiscal controls at borders. Estimates prepared by the Commission of the current costs of complying with border formalities
of several
In particular, Denmark - which has recently reduced its budget deficit at considerable political cost would be required to sacrifice about 10% of its total tax revenue and the figure for Ireland, which Table 6 Revenue Consequences of Fiscal Approximation Assuming Unchanged Spending Patterns Changes in revenuefiom excuse duties and VAT As percentage of As percentage of indirect tax receipts total tax receipts
to:
by cross-border
26 92 42 130 46 75 Challenge,
trade
Exports
lmports
Cecchini, The European
Although existing tax differences generate comparatively few artificial incentives to source products in one country rather than in another, removal of these be of particular
in intra-EC
are contained in Table 5. They are lowest in Benelux, where an internal market is already close, and highest in Italy.
The effects are generally complex. For most producers, there will be gains and losses in different markets (e.g. alcohol and tobacco taxes will fall substantially in Denmark and rise correspondingly in Greece). The balance of taxation between different products will also be important (e.g. the current advantage of wine over spirits will be reduced in nost countries), so will changes in the structure of the tax regime (e.g. the balance between specific and ad valorem taxation has important implications for the competitive position of different producers).
will
costs per consignment
Belgium Denmark France West Germany Ireland Italy Netherlands UK Source:
Lee, Pearson
+3 -27 -6 +6 -10 -3 +6 +2 and Smith
(1988)
+0.7 -9.5 -1.7 +1.6 -4.4 -0.8 f1.4 +0.6
EUROPE
continues to run a major budget deficit, would be close to 5%. At this point, serious doubts about the political realism of these proposals must begin to enter. Implementation of the Communism’s proposals would require, for at least half the member states of the Community, the most radical fiscal reform in their history, such a reform would not be promoted by, or the result of, internal political pressures: indced in almost all cases it would involve a range of spec.ific measures which would be unattractive both to tile principal interest groups and to public opinion generally within the countries concerned. Like them in fiscal systems or not, the current differences across the member states of the Community are not the result of mere vexatiousness - they are the product of divergences in fiscal history, public views and the political balance. This is an observation whi& is reinforced by consideration of the administrati\re issues involved. At present, VAT is operated by self-reporting subject to simple checks: an inspector will check to ensure that output has been properly accounted for (either as a taxable supply or as an export) and that claims for refund or tax offset are properly supported by invc’ices from other registered traders. The quality of administration varies widely across the Community: as a broad generalization it is considerably higher in the northern European states than in the south, and in s3me countries VAT evasion is endemic. In the post 1992 world, documentation issued anywhere in the Community would be acceptable evidence in any other state and verification would be accomplished by International cooperation. Similar requirements would apply to excise duties. Now it is not inconceivable that such a system could be nade to work although it would certainly be an undertaking of formidable proportions. But if it were to be accomplished by 1992 or indeed in any realistic timescale, it would be essential to develop the systems and relationships needed to make it operate well before the date at which collection of indirect tax revenue throughout the Community became deptlndent on it. There is at present no evidence that such activity is taking place at any serious level. Indc,ed there is little evidence that member states are taking any steps towards implementing the fiscal changes which the 1992 programme would require. Wit11 the possible exception of a reduction in the standard VAT rate in the Netherlands, few, if any, of tile major tax reforms which have taken place in several community states appear to have been inflL:enced by the requirements of 1992. The governments of Denmark, Ireland and the UK have made
WITHOUT
FISCAL FRONTIERS
343
clear, with varying emphasis, the difficulties which implementation would pose for them. But, given the extraordinarily political and economic momentum which has built up behind the 1992 programme, no industrial government is willing to be identified as But that does not mean that blocking progress. progress will be made. It is important to stress how fundamental this obstacle is. Under present administrative arrangements within the Community, the operation of border checks is essential to protect tax revenue so long as there are any significant differences in rates of VAT or excise duties within the Community. It is not the case that if half of what is needed to accomplish harmonization is accomplished, half the barriers can be dismantled or they can be reduced to half their size. Until a very high degree of commonality of tax structures and rates between member states is achieved, fiscal frontiers of the present kind will remain obstinately in place.
The Probable
Outcome
However, the virtual certainty that the Commission’s hopes will not be realised should not be interpreted as meaning that nothing will occur. Changes will certainly happen: the benefits of them are most likely to accrue to those who identify and anticipate them correctly. There are three principal options: 1992 is postponed 0 a two-tier community l more limited reform l
The European Community has, on many previous occasions, “stopped the clock” when negotiations on an issue. It is possible that on this occasion they would stop the calendar. 1992 would have many more than 365 days and the removal of border controls which everyone currently associated with 1992 will not happen until 1993 or 1994, or 1995. The weakness of this particular scenario is that there is no particular reason to think that the problems which prevent realisation of the Community ideals in 1992 will be any easier to resolve by 1993 or 1995. Perhaps Ireland’s budget deficit will by then have diminished - the problems that country faces if it has not will by then be enormous. But broader political difficulties will remain. These apply equally to implementing big reductions in taxation of alcohol or tobacco in countries which now tax products heavily and to the implementation of big increases is in the same taxes in countries which now tax them lightly. The problems of approximating VAT will be equally intractable. Although the deferral of 1992 is
344
JOHN KAY
certainly a likely event, the probability that the deferral would then prove indefinite must be rated high. The second option would be the development of a “two-tier” community. The fiscal adjustments required by the Commission proposals are considerably more severe for the outer group of Community states, in a geographical sense, than for the inner historic core. The changes demanded of the Benelux countries, France, Germany and Italy are considerably easier to implement than those needed in Denmark, Greece, Ireland, Portugal, Spain or the UK. This happy coincidence of geography and policy could be exploited to allow the creation of an area within the Community within which trade could take place freely and an area against which barriers would remain. Matters are not quite as simple as this suggest - in particular, the problems of integrating VAT administration in Germany and Italy remain but an outcome on these lines seems considerably more realistic than the full implementation. Those countries in the second tier, of course, would derive the worst of all worlds from this outcome. It is a scenario in which 1992 is a reality, but a reality from which they are excluded. This is precisely the position in which business in Austria, Sweden and Switzerland, in particular, already fears it might find itself. The possibility is that half the states of the Community will find themselves similarly placed. The third outcome is to pursue solutions which could, by administrative reform, allow the persistence of tax rate and tax base differences between member states while still achieving the elimination or substantial reduction of border controls as suggested, for example, by Cnossen and Shonp (1987). Indeed this could largely be achieved if the existing draft Fourteenth Directive - which provides for adjustments related to exports and imports to be administered domestically rather than at the frontier - were widely implemented. (It is the means by which the very liberal trade regime of Benelux currently tolerates tax rate differences and was also applied in Ireland and the UK until abandoned under pressure from domestic firms who thought it
too favourable to their foreign competitors). As yet, alternatives of this kind do not appear to have received serious attention as part of the 1992 programme and must be viewed as less probable than the postponement or two tier scenarios.
Can 1992 Happen? As matters stand at present, it must be regarded as extremely unlikely that fiscal frontiers within the European Community will actually be removed in 1992, or at any foreseeable date. This realistic assessment ought to be at the centre of any serious analysis of what 1992 means in practice. This does not mean that nothing will happen and that Europe can safely be ignored. It is likely that other trade barriers will be reduced - for example, that some progress will be made in promoting common technical standards and that non-tariff barriers to intra-European trade will be reduced. Moreover, once the Commission is brought to recognise the lack of realism of its own agenda it is likely that some more limited measures will be adopted which will achieve some, though not all, of The marketing campaign for the 1992 objectives. 1992 will have its own effects in promoting greater European integration even if objective reality changes very little - some of these are already evident. But the dream of Europe without trading frontiers is the most exciting vision that could be promoted. Sadly, it is likely to remain a dream.
References Cecchini, P (1988) The European Challenge, Wildwood House, Aldershot. Corn [87] 320; Commission communication on competition of the internal market: approximation of indirect rates and harmonisation of indirect tax structures. European Commission (1985): White Paper, Completing the Internal Market. Lee, C, M Pearson and S Smith (1988): Fiscal Harmonisation: an analysis of the European Commission’s proposals.
Europe Without Fiscal Frontiers: An Assessment John Kay Professor of Industrial
Policy and Director,
Centre for Business Strategy,
London Business School
Proposals for approximating and harmonising indirect taxes across Europe are central to the planned creation of a single European market in 1992. If implemented, the Commission’s proposals would have major direct and indirect effects for a wide variety of European business. They would also have very large effects on the revenue position, tax structures, and tax administrations of member states. For this reason, they are very unlikely to be implemented, and since partial harmonisation is no more possible than partial pregnancy, it follows that the realistic prospect of fiscal frontiers being dismantled in 1992, or in any forseeable time frame, is small. It is important that business planning should be based, not on loose generalisations about the coming single European market, but on a careful assessment of what changes are likely to be implemented in practice.
effects on firms whose market prospects are substantially influenced by tax or trade distortions (e.g. duty free services, VAT exempt activities).
Introduction
l
The European Commission has, as is well known, put forward a range of proposals for creating a single internal market within the European Community by the end of 1992 (European Commission, 1985). Much attention has been given to the possible managerial implications of such a development but comparatively little to the implications of proposals themselves. This paper examines these proposals in one, central, area: that of fiscal policy. These are explained in relative detail in Corn 1871 320.
This paper begins by identifying these effects. Once this is done, however, it quickly becomes apparent that the probability of their implementation in the firm presently proposed by the Commission or anything resembling it is negligible. The agenda that follows is then a somewhat different one.
Implementation of the 1992 plans would affect firms in a variety of ways. Ordered from the general to the specific, they include: major effects on the fiscal position of member states with resultant implications for the level of other (principally direct) taxes the facilitation of cross border trade, and sourcing as a result of reduced costs of border formalities greater cross border shopping by individuals effects on firms whose market prospects are substantially influenced by tax levels (e.g. drink and tobacco)
Are the fiscal proposals genuinely central to the 1992 project? l What are the options likely to be adopted in practice? l Can 1992 happen? l
The answers to these questions are central to any understanding or analysis of what the internal market means in practice.
What does the Commission
propose?
The fiscal package for 1992 has been described as “convergence by reference to points of departure
EUROPE
rather than points of arrival”. This means that the Commission has not asked the question “what would be the best tax structure for the Community as a whole?” Instead, it has sought to put forward a regime which, particularly in rate structure, represents an average of existing positions. Thus “it must be clearly understood that the present package is not an attempt to design an ideal fiscal system for the Community but a blueprint for the abolition of fiscal frontiers . (The Commission has) confined itself to setting out the minimum changes which must be made to . . achieve a sufficient degree of fiscal approximation” (Corn [87] 320). The plans for fiscal harmonization contained in the Commission’s proposal for completing the internal market relate only to indirect taxes. There are no immediate plans to promote further convergence of direct taxes - such as income tax, social security colltributions, or corporation tax - although these The ha,. t’ been the subject of separate discussion. taxes of principal concern are VAT - levied in all member states of the Community - and excise duties imposed on particular commodities, especially alcollolic drinks, tobacco products, and major fuels. The range of VAT rates currently charged in EC member states is shown in Table 1. The standard rate varies from 12% (Luxembourg, Spain) to 22% (Dtnnmark). The number of rates ranges from one in Denmark - which applies a flat 22% rate to almost all commodities - to seven in France. Before the the Commission had not prt sent 1992 campaign, bet-n seriously concerned to promote greater uniformity in rate structures. The Sixth Directive on some VAT, published in 1977, has encouraged con\‘ergence on the tax base. Most countries exempt he
Belk4um D&:mark Frailse Germany G rei*se IlX?l.lild Ital;,
Lu
2.1 - 13 6 0, 10 2, 9 3, 6 6
19
25, 33 334 36 _
18 12
38 _
16
30
12 15
33 -
22 18.6 l-1 1s 2s
WITHOUT
FISCAL
FRONTIERS
339
major technical problems in devising a satisfactory VAT regime - financial services and housing. Financial services are, in the main, exempt, and in most countries (although not the UK) new residential construction is taxed and rents are exempt from VAT. The scheme put forward by the Commission would require each country to adopt a common rate structure with a standard and a reduced rate. The plan does not insist on complete harmonization: each state would be free to choose a higher rate in the range 14%-19% and a lower rate in the range 4%-9%. There would, however, be complete convergence on the base. Current exemptions Ivould The lower rate would apply to mostly remain. foodstuffs, fuel, water supplies, medicines, books, and periodicals, and public transport. newspapers, All other goods and services would then be subject to the standard rate. The normal mechanism by which VAT is collected is that tax is chargeable on the whole of the output of a registered trader. If the purchaser is another registered trader in the same country, he can reclaim the VAT paid against his own potential liability. to another EEC country or Exports - whether elsewhere - are zero rated for VAT, however, so that they may be excluded from taxable output. Traders classify output themselves, but they may be required to provide evidence - including documentation of border controls - in produced for purposes support of their claim that tax is not payable on a particular exported portion of their output. When the goods are imported into another country which levies VAT (including all EEC states) tax is payable by the importer when the goods cross the frontier. In practice, the goods can normally be brought into the country against a guarantee of payment. Under the Commission’s proposals, exports to other member states would no longer be zero rated, and registered traders in other EEC countries would be treated as traders within the same country are now. Thus if a German firm buys materials from an Italian producer, it now reclaims the VAT paid (at German rates) by the German importer, or pays such VAT itself and offsets it against tax payable on its own output. In future, it would reclaim the VAT paid (at Italian rates) by the Italian exporter. A side effect - of this change - but a critical one - is that the VAT which was formerly paid in Germany, and repaid in Germany, would no\\’ be paid in Italy and repaid in Germany. Until Europe is a great deal more united than it is now, this outcome is not likely to be congenial to the German government. The EEC would therefore establish a clearing house in which
340
JOHN KAY Italian producer
all payments were redistributed to their country of origin. Figure 1 illustrates the current procedure which distinguishes the claim of transactions by the place of residence of the purchaser. Figure 2 illustrates the position after 1992, in which the two claims appear identical to the producer, and a side transaction takes place by means of the clearing house. Most EC member states impose substantial excise duties on alcoholic drinks, tobacco, and petrol. There are, however, massive differences in the tax structures adopted and in rates of tax. There are three principal categories of alcoholic drink - spirits wines and beer. Northern European countries tend to tax all drinks more heavily and wine producing states tax wine lightly, if at all (Table 2). Taxation of spirits and beer is normally related to the alcoholic strength of the product, that of wine based on the volume. The Commission’s proposals represent an arithmetic average of the existing levels of these taxes. Tobacco is subject to two types of tax (in addition to VAT) - a specific duty, chargeable per cigarette, and an ad valorem tax, based on the price of the cigarettes. There are considerable variations in the level and structure of these taxes across countries (Table 3). Ag am, what is proposed is that all states should levy tax at the (unweighted) average rate of individual countries.
-
National
border
ri
Italian purchaser
I
I
German purchaser
I
J Italian purchase1
Italian VAT reclnimcd
German purchaser
Italian VAT reclaimed
EUROPE
Table 2 Taxation of alcoholic drink in the EEC (rate in ECU at April 1986) Spirits’
Bee?
Win2
Denmark Ireland UK Netherlands Belglum Germany France Luxembourg Spain Portugal Italy Greece
10.5 8.17 7.45 3.80 3.76 3.52 3.45 2.53 0.93 0.74 0.69 0.14
1.57 2.79 1.54 0.34 0.33 0.03 0.13 -
0.71 1.13 0.68 0.23 0.13 0.07 0.03 0.06 0.03 0.09 0.17 0.10
EC proposal
3.81
0.17
0.17
* per 0.75 litre bottle, standard strength 2 per litre 3 per litre, 1050 original gravity SOIULi.
Table 3 Tax&ion April 1986)
WITHOUT
of cigarettes
Specific tax
Denmark Ireland UK Germany Netherlands Belgium Italy Luxembourg France Portugal Greece Spain
1.52 1.00 0.96 0.52 0.24 0.05 0.03 0.03 0.03 0.04 0.01 0.01
EC proposal
0.39
FISCAL FRONTIERS
341
in the EEC’ (rate in ECU at
Ad valorem Cux (%, inch VAT) 39 35 34 44 54 66 69 64 71 63 58 35
Tax per packet
2.76 1.88 1.76 1.29 0.97 0.87 0.73 0.51 0.51 0.50 0.26 0.12
52-54
’ for cigarettes in the most popular price category (this tends to be relatively cheaper for the countries lower in the table). Source: European Commission
European Commission
Diesel fuel - used mostly, but not exclusively, by commercial hauliers - is everywhere taxed more lightly than petrol - used mostly, but not exclusively, by private motorists. Averaging of the tax rates would lead to a tax on petrol roughly twice the level imposed on derv (Table 4).
Because the rates of tax on all these commodities alcohol, tobacco, petrol - are high, the risks of tax evasion are considerable and all countries adopt reasonably rigorous controls in an attempt to reduce its incidence. rhese controls are of two principal types - registration of premises and physical marking of commodities. A factory in which a dutiable product is made, or a warehouse in which it is stored, must be registered with the revenue authorities. The goods in question may then be transferred to some other registered establishment, or exported, under close supervision. If they are is removed from the premises for any other purpose, duty becomes payable. The second mechanism involves commodity marking. In Britain, for example, refined oil products whit,h are not for sale as petrol (and are therefore subject to a lower rate of duty) are dyed so that improper use can be readily detected. In France, wintx must be stamped as duty paid before it is bottled, and in several EEC countries, tax stamps or “bar,deroles” must be affixed to packets of cigarettes. Possession of unmarked goods by someone other than an authorised trader then becomes prima facie evidence of tax fraud.
The Commission’s proposals for excise duty harmonization would rely on registration of premises. Goods would move under seal and supervision between registered premises in different parts of the Community, but when they left such premises (other than for export from the Community) duty would be payable. With a single rate of tax applying within the Community, duty paid goods could then move freely between countries. Since it is not proposed that the clearing house will apply to excises, it would appear that duty would accrue to those states in which production or storage facilities happened to be located.
The Implications The effect on business of these changes, if implemented, would be of two kinds. There are effects which result from the changes in rates, and there are effects consequent on the approximation or harmonization of taxes and tax structures across the community. The direct effect of rate changes are principally of concern to a limited group of industries, although of massive concern to them. The most obvious impacts are on: l l l
alcoholic drink producers and retailers cigarette manufacturers and retailers petrol wholesalers
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JOHN KAY
4 Taxation of motor fuel ECU at April 7986)
Table
Source:
in the EE (rate per litre in
Table 5 (ECU)
Average
Petrol
Derv
Country
Italy Denmark Greece Portugal France Ireland UK Netherlands Belgium Germany Luxembourg Spain
0.53 0.46 0.42 0.41 0.39 0.38 0.31 0.29 0.25 0.24 0.20 0.20
0.12 0.19 0.12 0.18 0.19 0.29 0.26 0.08 0.12 0.20 0.10 0.03
Belgium France Germany Italy Netherlands United Kingdom
EC proposal
0.34
0.18
Source:
European Commission
There will also producer:
be effects
on other
categories
of
gainers or losers from harmonization in the rate base (e.g. producers of certain foodstuffs) l industries subject to minor excise duties (e.g. German distributors of coffee and tea) l firms and industries benefitting from duty free trading (e.g. producers of major international brands, ferries, airports) l
l industries l
exempt
industries affected individuals
relevance from
harmonized
VAT shopping
34 87 79 205 50 49 Table 2.2
The effects on national tax structures and government revenues will certainly be as substantial as the effects on business. The implications of the changes in tax systems are major. They include: the termination of zero rating under VAT in Ireland and the UK the introduction of wine taxation in Germany, France, Italy, Portugal and Spain a reduction in taxes on alcohol in Denmark of around 60% for spirits, 90% for wine and 75% for beer the halving of tobacco taxation in Ireland the doubling of cigarette prices in Greece The overall fiscal impact on the budget member states is considerable (Table 6).
by
More wide ranging effects on all firms which do, or might, trade throughout an integrated market will come from the lowers costs and greater flexibility associted with the absence of fiscal controls at borders. Estimates prepared by the Commission of the current costs of complying with border formalities
of several
In particular, Denmark - which has recently reduced its budget deficit at considerable political cost would be required to sacrifice about 10% of its total tax revenue and the figure for Ireland, which Table 6 Revenue Consequences of Fiscal Approximation Assuming Unchanged Spending Patterns Changes in revenuefiom excuse duties and VAT As percentage of As percentage of indirect tax receipts total tax receipts
to:
by cross-border
26 92 42 130 46 75 Challenge,
trade
Exports
lmports
Cecchini, The European
Although existing tax differences generate comparatively few artificial incentives to source products in one country rather than in another, removal of these be of particular
in intra-EC
are contained in Table 5. They are lowest in Benelux, where an internal market is already close, and highest in Italy.
The effects are generally complex. For most producers, there will be gains and losses in different markets (e.g. alcohol and tobacco taxes will fall substantially in Denmark and rise correspondingly in Greece). The balance of taxation between different products will also be important (e.g. the current advantage of wine over spirits will be reduced in nost countries), so will changes in the structure of the tax regime (e.g. the balance between specific and ad valorem taxation has important implications for the competitive position of different producers).
will
costs per consignment
Belgium Denmark France West Germany Ireland Italy Netherlands UK Source:
Lee, Pearson
+3 -27 -6 +6 -10 -3 +6 +2 and Smith
(1988)
+0.7 -9.5 -1.7 +1.6 -4.4 -0.8 f1.4 +0.6
EUROPE
continues to run a major budget deficit, would be close to 5%. At this point, serious doubts about the political realism of these proposals must begin to enter. Implementation of the Communism’s proposals would require, for at least half the member states of the Community, the most radical fiscal reform in their history, such a reform would not be promoted by, or the result of, internal political pressures: indced in almost all cases it would involve a range of spec.ific measures which would be unattractive both to tile principal interest groups and to public opinion generally within the countries concerned. Like them in fiscal systems or not, the current differences across the member states of the Community are not the result of mere vexatiousness - they are the product of divergences in fiscal history, public views and the political balance. This is an observation whi& is reinforced by consideration of the administrati\re issues involved. At present, VAT is operated by self-reporting subject to simple checks: an inspector will check to ensure that output has been properly accounted for (either as a taxable supply or as an export) and that claims for refund or tax offset are properly supported by invc’ices from other registered traders. The quality of administration varies widely across the Community: as a broad generalization it is considerably higher in the northern European states than in the south, and in s3me countries VAT evasion is endemic. In the post 1992 world, documentation issued anywhere in the Community would be acceptable evidence in any other state and verification would be accomplished by International cooperation. Similar requirements would apply to excise duties. Now it is not inconceivable that such a system could be nade to work although it would certainly be an undertaking of formidable proportions. But if it were to be accomplished by 1992 or indeed in any realistic timescale, it would be essential to develop the systems and relationships needed to make it operate well before the date at which collection of indirect tax revenue throughout the Community became deptlndent on it. There is at present no evidence that such activity is taking place at any serious level. Indc,ed there is little evidence that member states are taking any steps towards implementing the fiscal changes which the 1992 programme would require. Wit11 the possible exception of a reduction in the standard VAT rate in the Netherlands, few, if any, of tile major tax reforms which have taken place in several community states appear to have been inflL:enced by the requirements of 1992. The governments of Denmark, Ireland and the UK have made
WITHOUT
FISCAL FRONTIERS
343
clear, with varying emphasis, the difficulties which implementation would pose for them. But, given the extraordinarily political and economic momentum which has built up behind the 1992 programme, no industrial government is willing to be identified as But that does not mean that blocking progress. progress will be made. It is important to stress how fundamental this obstacle is. Under present administrative arrangements within the Community, the operation of border checks is essential to protect tax revenue so long as there are any significant differences in rates of VAT or excise duties within the Community. It is not the case that if half of what is needed to accomplish harmonization is accomplished, half the barriers can be dismantled or they can be reduced to half their size. Until a very high degree of commonality of tax structures and rates between member states is achieved, fiscal frontiers of the present kind will remain obstinately in place.
The Probable
Outcome
However, the virtual certainty that the Commission’s hopes will not be realised should not be interpreted as meaning that nothing will occur. Changes will certainly happen: the benefits of them are most likely to accrue to those who identify and anticipate them correctly. There are three principal options: 1992 is postponed 0 a two-tier community l more limited reform l
The European Community has, on many previous occasions, “stopped the clock” when negotiations on an issue. It is possible that on this occasion they would stop the calendar. 1992 would have many more than 365 days and the removal of border controls which everyone currently associated with 1992 will not happen until 1993 or 1994, or 1995. The weakness of this particular scenario is that there is no particular reason to think that the problems which prevent realisation of the Community ideals in 1992 will be any easier to resolve by 1993 or 1995. Perhaps Ireland’s budget deficit will by then have diminished - the problems that country faces if it has not will by then be enormous. But broader political difficulties will remain. These apply equally to implementing big reductions in taxation of alcohol or tobacco in countries which now tax products heavily and to the implementation of big increases is in the same taxes in countries which now tax them lightly. The problems of approximating VAT will be equally intractable. Although the deferral of 1992 is
344
JOHN KAY
certainly a likely event, the probability that the deferral would then prove indefinite must be rated high. The second option would be the development of a “two-tier” community. The fiscal adjustments required by the Commission proposals are considerably more severe for the outer group of Community states, in a geographical sense, than for the inner historic core. The changes demanded of the Benelux countries, France, Germany and Italy are considerably easier to implement than those needed in Denmark, Greece, Ireland, Portugal, Spain or the UK. This happy coincidence of geography and policy could be exploited to allow the creation of an area within the Community within which trade could take place freely and an area against which barriers would remain. Matters are not quite as simple as this suggest - in particular, the problems of integrating VAT administration in Germany and Italy remain but an outcome on these lines seems considerably more realistic than the full implementation. Those countries in the second tier, of course, would derive the worst of all worlds from this outcome. It is a scenario in which 1992 is a reality, but a reality from which they are excluded. This is precisely the position in which business in Austria, Sweden and Switzerland, in particular, already fears it might find itself. The possibility is that half the states of the Community will find themselves similarly placed. The third outcome is to pursue solutions which could, by administrative reform, allow the persistence of tax rate and tax base differences between member states while still achieving the elimination or substantial reduction of border controls as suggested, for example, by Cnossen and Shonp (1987). Indeed this could largely be achieved if the existing draft Fourteenth Directive - which provides for adjustments related to exports and imports to be administered domestically rather than at the frontier - were widely implemented. (It is the means by which the very liberal trade regime of Benelux currently tolerates tax rate differences and was also applied in Ireland and the UK until abandoned under pressure from domestic firms who thought it
too favourable to their foreign competitors). As yet, alternatives of this kind do not appear to have received serious attention as part of the 1992 programme and must be viewed as less probable than the postponement or two tier scenarios.
Can 1992 Happen? As matters stand at present, it must be regarded as extremely unlikely that fiscal frontiers within the European Community will actually be removed in 1992, or at any foreseeable date. This realistic assessment ought to be at the centre of any serious analysis of what 1992 means in practice. This does not mean that nothing will happen and that Europe can safely be ignored. It is likely that other trade barriers will be reduced - for example, that some progress will be made in promoting common technical standards and that non-tariff barriers to intra-European trade will be reduced. Moreover, once the Commission is brought to recognise the lack of realism of its own agenda it is likely that some more limited measures will be adopted which will achieve some, though not all, of The marketing campaign for the 1992 objectives. 1992 will have its own effects in promoting greater European integration even if objective reality changes very little - some of these are already evident. But the dream of Europe without trading frontiers is the most exciting vision that could be promoted. Sadly, it is likely to remain a dream.
References Cecchini, P (1988) The European Challenge, Wildwood House, Aldershot. Corn [87] 320; Commission communication on competition of the internal market: approximation of indirect rates and harmonisation of indirect tax structures. European Commission (1985): White Paper, Completing the Internal Market. Lee, C, M Pearson and S Smith (1988): Fiscal Harmonisation: an analysis of the European Commission’s proposals.