Europe’s Elaborate Tax Dance

Last week, leaked documents indicated that “some firms have enjoyed effective tax rates of less than 1 percent on the profits they’ve shuffled into Luxembourg”. That corporations have used Europe’s complex tax structures to minimise their tax bills is not per se news. Nonetheless, the story has run on because it touches on politically sensitive areas such as growth, austerity, sovereignty and the reputation of the President of the European Commission.

With apologies to Marx, tax is the spectre now haunting Europe. Ever since the financial crisis of 2008, European governments have compared their tax incomes and their planned outgoings only to find, like Mr Micawber, that they do not add up. If the claims about Luxembourg are true, it would mean other EU governments have missed out on billions in tax revenue. To give some sense of scale, 2013 saw €240.1bn of foreign direct investment (FDI) in Luxembourg, including much of the corporate revenue moved into it; this compares to €7.4bn FDI in Germany and €326.6bn in the EU as a whole (watch here, from 30 seconds onwards). This news could easily drive further support for political parties arguing against austerity, such as Podemos in Spain or Syriza in Greece, as well as those parties arguing against the EU itself, such as Front National and UKIP. Political shifts in either direction could destabilise an increasingly fragile EU consensus on tackling low/no growth.

Europe’s concerns about tax are not unique. America is riven with debate about tax inversions, and base erosion and profit shifting (BEPS) is a global issue raised by the G20. Europe nonetheless faces some very specific challenges. It has long been home to states with histories of banking secrecy, some outside the EU, such as Liechtenstein and Switzerland, but some most assuredly within it, e.g. Luxembourg. Furthermore, some Member States have fostered FDI by creating business-friendly tax regimes, effectively competing with other Member States on this basis, e.g. Ireland.

There are already active EU investigations of tax regimes in Ireland, Luxembourg and the Netherlands, with others pending for France, Germany, Malta and the United Kingdom. Certain countries already being forced to change their models, but what is interesting with these particular investigations is that the EU seems to be focusing on whether the tax regimes count as ‘state aid’. This angle could bypass Member State’s sovereign control of their taxation by asking if the tax regimes equate to subsidies that are illegal under Single Market rules, an area wherein the Commission holds the whip hand rather than the Member States.

Meanwhile, companies that have used (quite legally) advantageous tax regimes may be pushed into costly changes in their business structures. Or worse, they may suffer reputational harm at the hands of campaigners and politicians looking to align with popular sentiment. At a time when the EU wants to foster jobs, growth and investment, alienating business would seem nonsensical—but it very well might happen.

On their own, the risks of outraged governments, voters and businesses would be bad enough for the Commission President, Jean-Claude Juncker. Worse still, however, is the fact that when he was Luxembourg’s prime minister from 1995 to 2013, he signed off on some of the laws at the heart of his nation’s tax structures. He is neither currently involved in the EU investigations nor has he fully recused himself, and those willing to use anything to blacken the name of the EU have been given another weapon to wield.

The challenges of tax within the EU are not new, but whilst the economy was heedlessly buoyant people could avert their gaze from this ghost at the feast. Today, now the table is bare, the spectre cannot be ignored and there will have to be change.