Fiscal Forum: Future of the EU Tax Mix with Dr. Jost Heckemeyer

In October 2024, I had the opportunity to interview Professor of Business Accounting and Taxation at the University of Kiel, Dr. Jost Heckemeyer, about the future of the EU taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. mix. A lightly edited transcript from that interview is below and shows that there is a trade-off between stability and flexibility in European tax policymaking. It also shows that there ought to be a balance between fairness and competitiveness when thinking about improving tax policy.

Sean Bray: How would you characterize the current tax mix in the EU?

Jost Heckemeyer: That’s an interesting question, actually. Before talking about the tax mix itself, I think it’s important to acknowledge that the EU tax policy mix might mask the substantive heterogeneity in taxation that we find at the Member State level.

In the EU, talking about direct taxation in particular, but more generally as well, the Member States are allowed to tax what they want, when they want, and how they want. Thus, the EU tax policy mix is a bottom-up result. It comes bottom-up from the level of the Member States, and we can then observe what an aggregate EU tax policy mix looks like. We see that the overall tax burden in the EU amounts to about 40 percent of GDP with some substantial heterogeneity at the Member State level. For example, we have an overall tax burden that amounts to 46 percent of GDP in France, while on the other hand, we have a tax burden of only about 20 percent of GDP in Ireland.

If we look at the types of taxes that are levied in the individual Member States, we also see some heterogeneity. Looking at the aggregates for the European Union, we see that social security contributions come first in the overall mix. Then, we have the personal income tax, the value-added tax (VAT), and then in fourth place, the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. . Once again, looking just at the aggregates for the EU masks considerable heterogeneity in the Member States. In Denmark, for example, social security contributions only play a minor role, but the personal income tax plays a much more important role.

If I want to characterize the EU tax policy mix over time, I look at the numbers once again. Interestingly, one characterization would be that the EU tax policy mix has turned out stable over time. There have not been too many changes in the mix. So, on aggregate, about 40 percent of GDP. If you look back over the last 10 or 20 years, the tax burden was also around 40 percent of GDP.

If you look at the types of taxes, we have always had social security contributions, personal income taxes, the VAT, and corporate income taxes, which play the most important role. Meanwhile, property taxes and even environmental taxes are a little bit on the decline in terms of their share in the overall tax policy mix. So, what is the takeaway from that? My takeaway from the stability over time of the EU tax policy mix and the key role that these major tax types play is that if we want to integrate new incentives into the tax system, or if we want to close certain loopholes that we dislike, we should revisit those main tax types.

Looking at Member States and the European Union, they have been quite active in inventing new taxes over the last few years. Thinking about ideas surrounding digital service taxes or the global minimum tax, these have been new inventions that have been added to the tax policy mix and are new to the tax environment. However, given the overall importance of personal income taxes, corporate income taxes, and the VAT, it might have made as much sense to think about amendments or enhancements of the existing tax types. So, thinking about taxation of digital firms we have discussions about Pillar One. We have digital service taxes, but one could also think about enhancements of the VAT, which already plays an important part in the tax policy mix. Similar idea to thinking about restricting tax avoidance. We now have the global minimum tax. But why not think, alternatively, about enhancements of the income tax system by means of additional withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. taxes on interest or royalty payments? In other words, why not link innovations to the existing policy mix, instead of introducing ever more and new additional taxes that increase compliance costs and complexity, but those might not really be game changers.

Especially think about the taxation of digital firms, so the digital business models. We say they lack physical nexus. So, we must redefine nexus rules, and we must reallocate taxing rights. So, we think about Pillar One. Those countries that are not patient enough to wait for Pillar One have introduced digital service taxes which are actually not consistent with the principles that generally exist in our more traditional tax mix. The digital service tax is a gross tax. It’s not consistent with the net principle. And we see other examples where we introduce new types of taxes circumventing the old traditional tax mix, in order to address certain issues that we might have been able to address by resorting to the more traditional types of taxes and by aligning these new inventions to the principles that are well established.

Sean Bray: What do you think should happen in the EU over the medium term to make the EU fiscal space more stable and democratically legitimate? Do you think the EU should be considering qualified majority voting for tax policy?

Jost Heckemeyer: The first part of my answer is that I’ll say I’m not a political scientist. Discussing the institutional setting as it relates to democratic legitimacy is not my expertise. However, let me talk a little bit about the stability part because I know that if we consider domestic tax systems, and we think about the key characteristics of tax systems as we like them, stability certainly plays an important role. We have efficiency, transparency, and simplicity, but of course, we also have that stability here.

In the European context, I would like to take a second look at the stability issue because I think stability is not only something that we would consider as a positive; there can also be too much stability. Considering the EU policy in the field of direct taxation in particular, the global minimum tax that we’ve introduced in the European Union right now, these are all legal acts that have been introduced based on the unanimity principle. They have to be introduced unanimously, and they can only be changed unanimously. Considering this in the context of the global minimum tax, which in general is a multilateral approach, these are commitments made by the individual states and they commit, for example, to introduce a global minimum tax. Then, we can wait and see whether countries will follow their commitments, but we cannot be sure. We will see in the future if these commitments hold and whether countries will follow their commitments or whether they also will respond to whatever types of crises, whatever types of changes in the policy context, and they might be following their own interests, whatever they may be. And countries can even, despite these commitments that we have now on the table, respond flexibly in the future. We will see how many countries will introduce a global minimum tax, and whether they will really enforce the global minimum tax.

Now, in contrast, the European Union has always been very active and eager to be the front-runner in implementing these multilateral commitments. The European Union is basically the first to introduce the global minimum tax, and they’ve made this based on a unanimous decision in the Council of the European Union. In the future, they will only be able to make amendments to these new settings unanimously. What I fear a little bit is that in the sense of too much stability, the European Union here has taken some risks in its role as a front-runner because we will see what the future brings. We will see whether it will be in the interest of the EU as a whole or of individual Member States to follow this path of the global minimum tax and the possibility to respond to changes. So, my suggestion here talking about stability is that, in the European context, we have to think twice about stability, and we have to keep in mind that stability might also be something that can backfire in the end because there is a lack of flexibility.

Thinking about legitimacy. So, as I told you, I’m not a political scientist, but I can think about legitimacy in terms of what can be welfare-enhancing. I suppose that a tax policy that is welfare-enhancing is also a tax policy that is legitimate. Not talking about the political institutions here but talking about the sound tax policy that is legitimate in the sense that it’s in the interest of European voters. And I think that the fight against tax avoidance and the idea of restricting certain tax planning schemes that in the past might have led to zero taxed income are legitimate. I think, in general, addressing tax avoidance in the past has also meant addressing the genuine concerns of European voters. So that is legitimate, but still, I would propose improving the European tax policy approach by a more balanced approach. And by this, I mean policy that not only focuses on the fight against tax avoidance and on restricting certain tax planning schemes, but that also takes into account the fact that the European Union is in an international competition for growth, for investment, and must also care about competitiveness. I think it would be legitimate from the voters’ point of view to leverage the potential of the European Single Market because I think opening up the European Single Market would be welfare-enhancing.

That of course would mean addressing, and I will not go into the details here, but addressing the existing tax-related frictions which still exist in the European Single Market. We have 27 highly complex tax systems that are not harmonized. We have very limited possibilities of cross-border loss offset. We have a cumbersome and complex procedure of allocating profits across borders within multinational firms. We have high risks of double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. conflicts. We have lengthy infringement procedures. We have lengthy legislative procedures. So, there are still a lot of tax-related frictions in the European single market that we might address. And I think it seems highly advisable to shift the focus a bit in that direction as well.

Sean Bray: What role should corporate income tax and taxes on capital play going forward in the broader mix?

Jost Heckemeyer: I think overall, the tax policy mix is stable, and it will be more or less stable. So, I don’t think that the share of corporate taxation should increase or decrease.

The role that corporate income taxation and capital taxation can play is one linked to my ideas of increasing the competitiveness of the European Union. For example, focusing on the idea of leveraging the potential of the European Single Market and opening up the European Single Market. If we think about competitiveness, we know that in terms of taxpayers, and numbers of taxpayers, for example, the corporate sector is not the most important one. But if we think about the mobility of the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , the corporate sector and capital taxation in general have important roles to play. If the European Union wants to be an attractive place for investment and wants to attract investors from abroad but also open up the Single Market and stir investment inside the European Single Market, I think that many tax changes and reforms will need to be done. For example, fostering research and development. Of course, that is something that can be done within corporate taxation, within capital taxation more generally. But we should not be overly eager to look at the EU level here as the only player. We have to keep in mind that it’s the Member States themselves that are important players in that sector, and they can step by step enhance and improve their tax systems too.

Sean Bray: How would you describe a competitive tax system?

Jost Heckemeyer: That’s a very good question. A competitive tax system to me would be a tax system that is in balance. On one hand, it’s able to be competitive on an international scale. In the international comparison, the tax system has no prohibitively high tax rates and instead has competitive tax rates. It’s also a simple and transparent tax system. In addition, I think a competitive tax system is also one that has the acceptance of citizens, of the voters. On the one side, it’s an efficient competitive tax system that provides incentives for investors to invest, but at the same time, it has elements in it so that it is perceived as a fair tax system that makes everyone pay their fair share. I admit there may be some tension here. However, talking about fair share, if we are very honest, we also must admit that multinational firms, the corporate sector in general, should pay their fair share in the sense that they should not be able to avoid taxes entirely. So, they should be taxed on the corporate profits. They should be taxed exactly once, not twice and not zero times, but if we think about tax fairness in terms of redistribution we should, I think, be honest enough to say that it’s not very realistic to expect the corporate sector to finance the welfare state. We should acknowledge that fairness in that sense is something that has to come out of the taxation of personal income, less mobile tax bases that effectively can contribute to the redistribution of income. I think fairness in the multinational context will probably mean restricting tax avoidance.

Sean Bray: Can you describe how the corporate income tax serves as a backstop to the personal income tax?

Jost Heckemeyer: I think considering the corporate income tax as a backstop to the personal income tax is a pragmatic approach because it admits that we would have no other way of immediately taxing persons behind the corporations. If we would like to tax corporate investors immediately, that would be much more difficult, especially in an international setting.

Sean Bray: From an academic point of view, could you explain why capital gains or dividend tax rates are generally lower than labor tax rates? Is there a justifiable economic reasoning behind that?

Jost Heckemeyer: If you look at the general tax rates within European Member States, for example, you will regularly see that investment income—including dividend income or capital gains—is taxed at lower rates compared to progressive rates we find on labor income. And the key argument here relates to the integration of the personal income tax into the corporate income tax. So, if we look at corporations, we have basically two levels of taxation. First of all, the corporation is a taxable subject. It’s a legal person. Therefore, it’s taxed on its corporate income at the given corporate income tax rate of a particular country, and then this income can either be retained, or it can be distributed to the shareholders of the corporation. And once this income is distributed to the shareholders, they will have personal income, and they will be subject to the personal income tax. From an economic point of view, the profits that originally have been earned at the level of the corporation are effectively taxed twice: once at the level of the corporation, and once at the level of the investor. And the idea of taxing dividends or capital gains at a reduced rate, as compared to the ordinary personal income tax rates, is to mitigate double taxation. We try to avoid economic double taxation of dividend income or capital gains to avoid really meaningful economic distortions.

Sean Bray: Could you describe some political constraints in EU tax policy? Is there anything else that we missed or that you wanted to add to this conversation?

Jost Heckemeyer: First, there are legal constraints. We know that from the Treaty on the Functioning of the European Union (TFEU) in Article 115, it states that decisions must be made unanimously, and they have to improve the functioning of the Single Market.

And then we have the subsidiarity principle. In a sense, it also gives responsibility to the Member States, but of course, it’s also a psychological barrier to enhanced cooperation, to enhanced harmonization of the EU tax system because it gives policymakers a very good argument to hide behind to not move any further when it comes to cooperation in the field of taxation within the European Union. Interestingly, uniting for coordinated tax policy approaches in the European context seems to be much easier for policymakers under the mantra of fairness. Fairness of taxation, combating international tax avoidance—this has actually been the mantra behind which policymakers across Member States could rally during the last 10 to 15 years. I think we need to shift and consider adding to this mantra by opening up the Single Market. There has been a period in Europe in the 1990s and early 2000s, where this idea of opening up the Single Market played an important role. It has been a little bit pushed aside by this new mantra about fighting corporate tax avoidance. I think it would be helpful if policymakers would get more support once again for this idea of opening up the Single Market to cope with tax-related frictions in the Single Market. But interestingly, if you look at the public debate, if you look at talk shows, if you look at the public opinion, we still see that this fairness concern is still very prevalent. There has been a whole agenda focusing on base erosion and profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. , but we still see that fairness concerns seem to be very prevalent and still a key factor when people think about the international tax policy setting. I think, and that’s also something I take away from that discussion, there is still much more research needed on the drivers and the determinants of voters’ perceptions of fairness. What drives the fairness preferences and their perception of fairness of the corporate tax sector? So, it’s legitimate to have these fairness concerns, but I think that it’s time also to shift the focus a little bit and we will see whether this changes.

You asked me if there was still something missing. We were talking about stable and legitimate tax systems. We have to cope with tax-related frictions in the Single Market in order to levy the potential of the Single Market. But I think one additional thought here is about coherence of the tax system. I don’t want to be too technical here, but if you look at what’s going on right now, we have discussions about Pillar One, and those are still ongoing. And at the same time, we have had the Pillar Two global minimum tax. And now in the European Union, we have this proposal about Business in Europe: Framework for Income Taxation (BEFIT), which is basically a new label for a revised Common Consolidated Corporate Tax Base (CCCTB). We see that in these proposals (BEFIT, Pillar One, and Pillar Two), there are elements that are not in line and are incoherent. So, we introduce new rules. We try to cope with issues and problems that we face in the international tax landscape. And introducing these new rules we run into new inconsistencies. And I think legitimacy would also require coherence.

Take the global minimum tax. Right now, we have it in Europe, whether we like it or not. But if we now introduce BEFIT or Pillar One, we should make sure we take care that these new mechanisms are coherent in the sense that they follow the same logic and that we do not introduce another profit definition, another transfer pricing mechanism, another apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. formula. But for that, we need to really think things through.