Fiscal Forum: Future of the EU Tax Mix with Sérgio Vasques

In October of 2024, I had the opportunity to interview Dr. Sérgio Vasques, Professor of 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. Law at the Catholic University of Lisbon and former Portuguese Secretary of State for Tax Affairs, about the future of the EU tax mix. A lightly edited transcript from that interview is below. In his view, European nations face difficult choices in balancing fairness and growth in their tax systems, while the changing political environment will make it harder to reach consensus on tax policy. Dr. Vasques argues that more pragmatism and less ideology are needed.

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

Sérgio Vasques: To state the obvious, Europe is not a country. The European Union is a collection of 27 different countries with 27 very different tax systems. There is some degree of abstraction in discussing the European tax mix, just as in discussing the OECD tax mix. Obviously, we can draw a portrait of the whole, as a tax mix that relies to a large extent on the taxation of income, where we have had some progress regarding corporate income taxes. Consumption taxes have been relatively stable, with value-added tax (VAT) making up for the loss of excise duties. But this picture really hides important differences among the Member States. Those differences result from tradition, from administrative capacity, from the resistance of taxpayers, from the degree of anesthesia we want from the system. And to the extent that these differences result from conscious political choices, those choices still are mostly of national governments and not so much of the European Union.

In regard to the European tax mix, the best we can say is that it has served its historical purpose. It has enabled European governments to set up generous welfare states and affluent, stable societies. That’s no small feat. There are challenges ahead, however. We have an aging population, greater mobility of labor and especially of qualified workers. We have an economy that is not as competitive as it was in the past, and deindustrialization is hitting the very core of Europe. All of this will force us into hard choices regarding the structuring of personal income taxes, social contributions, value-added tax, environmental taxes, and so on.

Sean Bray: What improvements do you think need to be made in the medium term for a stable and democratically legitimate European tax system?

Sérgio Vasques: Tax systems are a product of political systems. In Europe, our political scene is undergoing a major transformation, possibly the most important transformation since the Second World War. Politics is now much more polarized, with the party system fragmenting. Mainstream parties are collapsing everywhere. At the domestic level, consensus on tax policy has now become harder. In Portugal, we managed to undertake our major tax reforms in the 1980s, and we did that because there was a broad consensus among the center-left and the center-right parties. Nowadays, that would be entirely impossible.

At the European Union level, the question of the democratic deficit has been discussed for a long time. In the current context, we really must handle it with more caution, because Euroscepticism really is spreading across the continent. Many of the recent initiatives by the European Union or by the European Commission relate to mitigating or eliminating the transaction costs for businesses operating in the European markets. BEFIT, HOT, ViDA, and all of that. As long as the European Union keeps to that agenda, I think there will be no question of political legitimacy. But it will be a different thing when it comes to devising new supranational taxes or imposing stricter rules on Member States that limit the taxing powers of national governments. If we are to preserve some democratic legitimacy for the European tax system, there should be restraint, and maybe tax policy should be deprioritized in the European agenda for its own good.

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

Sérgio Vasques: Both areas have some promise and some risk in different measures. When it comes to corporate income taxes, we are all aware that there is an opportunity and a necessity to broaden 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.. Many of the initiatives from the European Union are going in that precise direction. The most recent figures tell us that about 20 percent of revenue is lost to 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. and evasion. So, clearly, there is progress to be made in reducing the compliance gap, just as we did with value-added tax. But there are also difficulties. These initiatives demand a great deal of cooperation and the ability of the European Union to project its soft power on the international tax agenda. That is one factor. Also, in that process, there is some risk in demonizing big business in a continent that creates so few of them. So, there are some risks here, but, on the whole, the rewards seem to be greater.

It is not so clear when it comes to taxes on capital. Wealth taxes can generate some revenue, and there are some very optimistic estimates going around, but the truth is that experience shows net wealth taxes are not easy to implement. Also, the risk of capital flight cannot be ignored. In the past few years, many European states have set up privileged tax regimes for high earners and skilled professionals, and those schemes have had some success. These people obviously are sensitive to tax rates. That’s not really news, but it should inspire some caution.

Inheritance taxes are different in the sense that they are easier to implement, and we have more experience in fine-tuning them. There’s no doubt they can play a role in mobilizing revenue and reducing inequalities, but they are also a signal of discouragement. Europe badly needs a tax system that gives people good reason to work, invest, and succeed. In all this discussion, maybe we should not obsess over the Gini coefficient.

Whatever the case, taxes on capital probably cannot gain much traction in Europe in the short term, the reason being that the left really is receding in the political scene. I don’t see many European governments willing to champion a return to the taxation of inheritances or to replicate the French solidarity tax.

Sean Bray: What tax policy considerations do smaller Member States face compared to larger Member States, and what lessons could larger Member States learn from smaller ones?

Sérgio Vasques: Obviously, there are disadvantages to being small, and especially to being small and peripheral. It is harder to influence EU tax policy, and you must sacrifice more of your revenue or more of the coherence of your tax system to compensate for the advantages that businesses have in larger economies. But, then again, these disadvantages are not inescapable. Ireland has shown us there is a different way to tax corporations. The Baltic states show us there is a different way to structure personal income taxes. And even in Portugal, we make use of a special regime for non-habitual residents that has drawn in tens of thousands of skilled professionals. What this really shows is that smaller nations can also have advantages, if they are smart, creative, more pragmatic, and less ideological.

Sean Bray: What do you make of tax fairness, and what would make the future EU tax mix fairer?

Sérgio Vasques: A fair tax system is a system that provides everyone with a fair chance of success. That obviously entails some degree of redistribution, but it also demands room for growth and success. A tax system should have something aspirational about it: a system that does not punish businesses for growing, professionals for being promoted, or parents for leaving the product of their work to their children. Within the EU, the major question regarding tax fairness relates to how to shift the tax burden away from labor. A tax system cannot be regarded as fair if workers pay 40 or 50 percent of their income. Probably, there is no way of doing this without sacrificing some progressivity. However, it is not clear whether anyone really is up for that. Maybe managing decline is a more appealing option for European governments and taxpayers.

Sean Bray: What role should environmental taxation have in the tax mix?

Sérgio Vasques: Twenty years ago, we had high expectations of the possibility of shifting taxes from labor to green taxation. In fact, that has not materialized. Environmental taxes have been losing their share in the tax mix, sometimes for good reason: because companies and consumers have changed their behavior. Still, this makes it hard to alleviate the burden on workers, and that is a failure of our tax policy in Europe. As to the tax mix, obviously, there is a problem with environmental taxation because the most important tax is the tax on fossil fuels, and we are shifting to electric vehicles, so there will be a drop in the revenues these taxes generate. That is something that the European Commission has already warned us about in the Fit for 55 package.