No Representation Without Taxation, Or How a European Savings Income Tax Could Be the Way Out of the Financial Deadlock

No Representation Without Taxation, Or How a European Savings Income Tax Could Be the Way Out of the Financial Deadlock

Theme: A stable, fair and efficient financial framework for the European Union can only be established if full-blown taxing powers are assigned to the Union. There are very good reasons why both Member States and European citizens might find a ‘European savings income tax’ attractive.

Summary: Failure to reach an agreement on the 2007-13 financial perspectives in the European Council of 16-17 June 2005 could plunge the Union into an acute financial and political crisis. How can this be avoided? First, by realising that a marginal reform of the present system is unlikely, unless its current inefficiency and unfairness increase, and thus merely postpones the crisis (and, quite probably, at a heavy price); secondly, by framing the problem in terms that would not only render agreement easier, but would also contribute to enhance the efficiency and fairness of Europe’s public finances. It is argued that this requires the explicit assignment of taxing powers to the Union matching the cost of the public goods and services to be provided by it. The political feasibility of such a structural change could be maximised if it is accompanied by the advocacy of a similar level of own resources in the hands of the Union, and if the tax assigned to the Union is a European savings income tax.

Analysis: The European Union is at a defining crossroads. After the clear and resounding No in both the French and Dutch referenda, the Constitutional Treaty, arguably the most ambitious European project in the last decade, is dead. The call made on 16 June by the European Council to ‘reflect together on this situation’ for a year or so is a call for a constitutional burial.

Some commentators have rushed to the conclusion that the negative constitutional moment has opened up the most acute crisis in European history. This is an exaggeration. First, the very fact that the Constitutional Treaty will not be ratified because of two negative national referenda reinforces, rather than undermines, the democratic principle at the European level, ie, the principle that the European Union should draw its democratic legitimacy directly from Europe’s citizens and not only indirectly from the citizens’ national representatives. In the long run, this is likely to reinforce, rather than undermine, the process of European integration. After all, was that not one of the main reasons for opening a constitution-making process in the first place? This is especially true given that, secondly, the debates which preceded the referenda clearly indicated that most citizens who voted against the Treaty did not reject the European integration project, or even the idea itself of writing a Constitution for the Union. Indeed, French and Dutch citizens seem to have expressed the desire for a Union that is fairer, more efficient and with a greater capacity to act, which they simply did not think the Constitutional Treaty would bring about. In brief, they rejected this Constitution because they wanted another Constitution for the Union. They were frustrated because they wanted more, not less Europe, and they feared the Constitutional Treaty would not deliver that.

But it would be equally wrong to come to the conclusion that the negative vote can only be salutary. The present setting can easily deteriorate into a long-lasting and acute crisis if Europe’s leaders are incapable of finding political answers to the unarticulated but firm will of Europe’s citizens.

The Union’s Financial Perspectives
Some elements of a major crisis are already in place. Less than three weeks after the two negative constitutional moments, the failure of the members of the European Council to reach an agreement on the financial perspectives of the Union for the period 2007-13 sowed further doubts among European citizens. It clearly reinforced the perception that national leaders make use of the Union to increase their own decision-making power, to the detriment of the citizens and their democratic representatives. A succession of similar fiascos might prove fatal to the Union.

Still, the negotiation of the next financial perspectives immediately after the two negative referenda is not only full of risks (as just indicated) but also of political opportunities. First, there is significant room for improvement, because the current system is clearly unfair, inefficient and conducive to paralysis. Secondly, there are very good reasons to believe that a clear-cut proposal for structural reform, consisting of financing the Union’s expenditure through European taxes (mainly through a savings income tax) would do away with the main reasons why certain Member States are likely to block an agreement, while increasing the Union’s fairness and efficiency. Let us consider both questions sequentially.

(1) The Shortcomings of the Current Financial System
The system is unfair because the taxes that European residents pay towards financing the Union depend not so much on their income levels (the ‘ability to pay’ principle) or on the degree to which they benefit from the existence of the European Union (the ‘benefit’ principle), but on the way in which the tax system of their country of residence splits the burden stemming from the national contribution to the Union. This is so because most of the money derives from national contributions to European coffers, calculated either by reference to the aggregate national income or to the economic base of Value Added Taxation. This runs contrary to the principle of non-discrimination on the basis of nationality, which is at the core of European Union law (Article 12, TEC), and runs foul of the constitutional traditions common to the Member States, which require that the tax burden is basically assigned according to the principles of ability to pay and of benefit.

The system is paralysing for two main reasons:

• First, current financial decision-making procedures foster not only the aggregation of interests at the national level, thus obscuring questions of individual distributive justice, but also promote the blind reproduction of the interests which have been defined as national ones. Once a given interest captures the national interest, so to say, it tends to remain no matter how much the circumstances change. This results in the configuration of financial negotiations as zero-sum games. This is clearly reinforced by the definition of national goals by reference to the net difference between the national contribution and the payments received from the European budget. This renders invisible the manifold benefits which each Member State derives from the existence of the Union. It results in bad economics, facile politics and poor negotiation outcomes.

• Secondly, because the procedures followed to approve the own resources decision and the financial perspectives multiply the veto options, to the point of rendering these among the most demanding decision-making legislative procedures in comparative world constitutionalism. Following the latest enlargement, the statistical probability of such decisions being adopted in time has come close to zero.

The system is inefficient because it deprives the Union of a (modest) policy means to contribute to the stabilisation of the European economy. Leaving aside the question of the size of the European budget, the manifold in-built rigidities in the financial decision-making procedure rule out even the faintest possibility of using the Union’s taxing and spending powers as a macroeconomic lever to help realise the objectives set in Article 2, TEC.

(2) Why Structural Change is Feasible
The alternative proposed here consists in: (a) maintaining the present level of expenditure at the European level; (b) changing the financial basis of the Union, or what is the same, doing away with national contributions, calculated either by reference to the national VAT base or to national income, and substituting them by genuine European taxes –this should not be done ‘overnight’, but the present system should be phased out as the new one is phased in, with the new system in full motion by 2013–; and (c) choosing a savings income tax as the main European tax, in symbolic and quantitative terms.

Such a structural change (1) is not radical, but calls for implementing a decision already adopted in 1970; (2) does make political and economic sense; (3) should be attractive to both Eurosceptics and Europhiles; and (4) will be conducive to agreement among Member States.

First, the proposal does not call for a radical reform, but merely for the implementation of the decision to furnish the Union with its own resource basis, already adopted in 1970! The Treaty which amended the TEC in that year, and which has been ratified by all new Member States since then, affirms as a matter of principle the power to tax of the Communities, and the phasing out of direct national contributions to the European budget. This decision was not fully implemented due to the chronic insufficiency of the own resources assigned to the Union in the late 1970s and early 1980s. It was severely qualified by the Fontainebleau European Council of 1984, which revived national contributions as the Union’s fourth resource. But it remains part and parcel of the Union’s constitutional law.

Secondly, it makes political and economic sense. This is so because it allows ‘operationalising’ the key democratic principle of no representation without taxation, making clearer to Europeans the costs and benefits of European policies and decisions, and thus overcoming the meaningless reference to aggregate national costs and benefits. More to the point, it would also create the structural conditions under which Europeans would have a clear reason to make use of their existing political rights at the European level, ie, to influence the Union’s tax and spending decisions, precisely the questions which constitute the bread and butter of national elections. Furthermore, it would also create the conditions under which financial powers could be used in more flexible ways, thus increasing the meaningfulness of political debate on the matter.

Third, the proposal should be equally attractive to those who fear the transformation of the European Union into a super-state and to those who regret the insufficient development of the Union’s political identity:

• Eurosceptics should be attracted by the association of structural reform with the maintenance (for the next financial period) of the present level of economic resources in the hands of the Union. Eurosceptics could present this as their victory since the budget would not be increased, but would remain for the time being at its present level (this is also a key factor to render the proposal palatable to net contributors experiencing political difficulties at the national level). Moreover, the proposal takes proper care of a major concern of Eurosceptics, namely, the Union’s insufficient accountability. As things stand now, the Union is perceived by European citizens as a spending, but not as a taxing institution. It thus avoids the political costs of collecting its own taxes. A reform which creates the structural conditions under which each public good or service provided by the Union comes hand in hand with taxes to be paid to the Union and directly felt by citizens would surely expose any inefficient policy or specific decision of the Union to heavy criticism. For example, it would create the conditions under which it could be clarified not only whether the Union should devote a high proportion of its resources to financing the Common Agricultural Policy, but also which kind of CAP meets the favour of the taxpayers. At any rate, the transparent exercise of taxing powers by the Union should increase the expectations of European citizens.

• But the proposal should also find favour among those who would prefer a larger European budget. They could regard the reaffirmation of the Union’s power to tax as a necessary step on the road towards wider and more democratically accountable European financial powers. Once the principle that the Union should collect its own taxes is granted and once the rigid aggregation of interests at the national level is dissolved, the conditions under which the kind of debates they favour could be possible would have been established. Not only would this clearly favour the reaffirmation of the powers of the European parliament, but the case for a higher level of expenditure at the European level would be rendered much easier, both procedurally and substantially, if a situation were to arise in which this would clearly act as a multiplier of economic activity in the Union as a whole (in the event of a structural economic shock, of a deep economic recession).

Fourth, the proposal would be conducive to agreement among Member States:

• By turning individuals into the main contributors to the European budget, it would cut the grass under the feet of those framing negotiations by reference to alleged national interests and to calculations of budgetary inflows and outflows. It would avoid the present aggregation of national interests and the framing of negotiations in zero-sum terms, which render the issues simply intractable. Financial debates at the European level would be normalised, as the reform would create the conditions under which considerations of aggregate efficiency, individual fairness and macroeconomic stabilisation would become dominant in the debates. Instead of focusing on which Member State should pay for what, debates would focus on the proper definition of tax bases, tax rates and the adequacy of expenditure to European citizens’ preferences. This would allow for the aggregation of interests across national borders, and their composition in ways not so different from those prevailing at the national level in most Member States.

• By progressively phasing out VAT, it would do away with one of the two key rationales underlying the British rebate.

• By founding the Union’s public expenditure on its taxing powers, it would reduce the costs of increasing or decreasing the size of the Union’s financial basis. Within due limits, it would only require increasing or decreasing the rates at which European taxes are collected (as is the case in Member States and their regions).

The European Savings Income Tax
The European savings income tax should be favoured as the main European tax, in symbolic and quantitative reasons, for four additional reasons.

First, savings income is no longer easy to locate in one Member State. European Union law, not national law, establishes the basic framework which allows European citizens to place their savings anywhere in the Union, at the same time that it provides them with guarantees about the security of their investments. Moreover, economic globalisation and technological developments have de facto undermined the capacity of Member States to effectively tax savings income. Only automatic exchanges of information between the tax administrations of Member States and the use of the Union’s economic muscle as an international actor vis-à-vis third states stand a chance of creating the conditions under which savings income can be effectively taxed. For these two reasons, the rationale for assigning taxation power to the Union, and not to Member States, should be obvious to all citizens.

Secondly, turning savings income taxation into a major source of Union finance would make it transparent that those who benefit most from the existence of the Union are those who pay for the Union, thus reconnecting the Union with the principle of ability to pay, which national constitutional traditions affirm as a central tenet when it comes to distribute the tax burden. This is precisely the opposite perception which prevails if VAT is the first European tax (as decided in 1970), since VAT is (fairly or unfairly) perceived as a regressive tax (given that the propensity to consume is higher the less income you earn).

Third, the potential revenue from a European savings income tax would dispel the fears of many chancellors of the exchequer. It would be below the present aggregate level of own resources in the Union’s hands. Thus, it would be a more suitable candidate than corporate income tax which, if assigned to the Union, would at least double the present level of own resources. At the same time, national resistance towards the Europeanisation of this tax should now be at its lowest, since it does not result in any net loss for national budgets. As already indicated, such income is at present virtually de-taxed.

Fourth, the affirmation of savings income taxation as an own resource of the Union would simply eliminate the tax roots of the British rebate. Not only would it be possible to progressively phase out VAT as an own resource of the Union, but it would also remove the intuitive appeal to the regressiveness of Value Added Taxation as a justification for a correction in the British contribution from the British government’s argumentation cards.

Conclusion: The sovereign and reflected will of Europe’s citizens against the Constitutional Treaty should not be seen as having plunged the Union into a crisis, but as leading us all into a defining moment. As Altiero Spinelli has repeated once again, we cannot wait for a solution to drop from the sky, but must strive to build one. Instead of indulging in a melancholic reflection on the future of a dead constitution, Europe’s leaders would do well to put forward proposals to answer the concerns expressed by French and Dutch citizens. A resolved structural change of the financial basis of the Union by granting it the power to tax savings income could be one way to address the desire of Europe’s citizens for a Union that is fairer, more democratic, more efficient and with a greater capacity to act.

Agustín José Menéndez
Ramón y Cajal Researcher, Universidad de León, and Fellow of the CIDEL research project, Universitetet i Oslo

Note: A more academic analysis appears in my ‘Taxing Europe’, 10 (2004) Columbia Journal of European Law, p. 297-338, and ‘The Purse of the Polity’, in Erik Oddvar Eriksen (ed.), Making the European Polity, Reflexive Integration in the EU, Routledge, London, 2005, p. 187-203.