Foe of Europe

Europe's attitude towards Britain can be summed up in the words of Shakespeare: 'Who is a man that is not angry?' - or, more bluntly - it is seen as a covetous and self-serving dodger.

One can understand, if not sympathise, the urge to leave the European super-state, curb immigration or shake off the restraints of the Single Market. Yet, what even anglophiles are struggling to defend is the country's move to become Europe's biggest tax heaven.

Tax competition, when governments poach businesses from each other by lowering taxes, has always been around. What has changed is the scale. In the last decades the growth in world trade has been phenomenal. Since 1980s global foreign direct investments, that is the money coming from abroad, increased fifteen times. For UK it means about £1 trillion and 100,000 new jobs a year.

The stakes are high and no one can afford loosing. “I want Britain to be the place international businesses go to,” the UK's former Chancellor George Osborne said. “Not the place they leave.” He slashed the corporation tax, already the lowest in G7, to 20 per cent and announced plans to come down to 17 per cent by 2020.

There are studies that suggest that tax competition doesn't work. Practice prove them wrong. When the US Economic Recovery Act of 1981 radically lowered tax rates on business capital, approximately $1 trillion of additional investment entered the United States. Great Britain has been keeping the taxes low for four decades and it is the number one investment destination in Europe.

There are, of course, downsides. When governments attract capital by lowing taxes, they risk entering the 'race to the bottom'. This is, mathematically speaking, a no-win game.

Let's us assume, for simplicity, that there are two countries with open borders and no currency control. If one country lows taxes, the cut would attract new capital. This will offset the loss of revenue due to the lower tax rate on the existing capital and overall revenue would grow. However, the other country will follow the suit, equalizing the playing field. Eventually, both countries will remain with the same tax base but lower rates and lower revenues.

This basic argument holds with multiple countries. Each country faces incentives to cut taxes. If, however, they all do, they all are worse off.

Big business loves it. While individual governments fight tax has become - as Sir Martin Sorrell, CEO of advertising group WPP, put it - “a question of judgment”, a matter of how a company wishes to present its “corporate social responsibility”.

The Organisation for Economic Co-operation and Development dubbed this new reality “global tax chaos”.

The solution seem obvious, restrict tax competition. That is why the European Commission has been trying to 'harmonise' taxation within the EU.

The EU's harmonisation plan means one tax base across the EU and different rates in the member states. According to the Common Consolidated Corporate Tax Base initiative, a predefined share of a company’s total income will be allocated to each member state and then taxed at a local rate. The attribution of income is in stark contrast with conventional principles: it would depend on sales, assets and workforce based in each country.

The proposal implies that a company headquartered in Ireland, with Europe's lowest rate of 12.5% but operating also in France will now have a large part of its income taxed in France at much less attractive rate of 33.3%. Although it may seem fair, the end result would be the loss of incentive for Ireland to keep its tax rate low. What is likely happen, therefore, is the gradual equalisation of rates across the EU somewhere closer to the higher end.

If we now return to our 'game model', we can see that it changed in a very material way: now the first country has even bigger incentive to low its taxes because the other country is unlikely to follow. The first country wins and 'the race to the bottom' does not happen.

“We would have the freedom to set the competitive tax rates and embrace the polices that would attract the world’s best companies and biggest investors to Britain," said Theresa May, the UK's Prime Minister, "If we were excluded from the Single Market we would be free to change the basis for the UK’s economic model.”

This may look like a threat, an intimidation tactic to keep access to the European market after Brexit. Well, it is not. Great Britain will almost certainly go on with the practice whether or not it gets 'a good deal'.