President Leyen’s trip across the Atlantic comes on the heels of a virtual meeting between Treasury Secretary Janet Yellen and European Commission Executive Vice President Valdis Dombrovskis that resulted in more vague statements about settling the EU’s concerns over the Inflation Reduction Act (IRA).
It is well documented that the EU sees 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. credits attached to U.S. domestic content requirements (which would not apply to the EU because it does not have a trade deal with the U.S.) as a clear World Trade Organization (WTO) violation.
Since the Act passed Congress last summer, the EU has been working with the Biden administration to find any loophole, short of rewriting the legislation itself, to limit the negative economic impacts on European companies selling goods in the U.S. In short, the EU is convinced it needs to protect European competitiveness. Therefore, the EU is drafting its own proposal called the Green Deal Industrial Plan to rival the U.S. policy and keep European firms from moving production abroad.
While the proposal is likely to be fully released in mid-March, the EU has said that it will continue the green subsidy race by pouring billions of euros into renewable energy investment. Furthermore, Germany and France have pushed for a “matching clause” under looser EU state aid rules that would allow Member State governments to match subsidies granted by non-EU countries to prevent firms from moving production abroad despite the risk that firms could use this policy as leverage to create subsidy bidding wars between governments. Some countries have even called for new EU debt to fund more ambitious subsidies. This is despite the fact that, on average, the EU has already spent more than €70 billion each year on renewable energy subsidies since 2015.
While a western subsidy war (in the middle of a global energy crisis nonetheless) is worth trying to diplomatically tamper, European policymakers are missing the bigger picture.
According to Tax Foundation’s 2022 International Tax Competitiveness Index, 10 EU Member States rank below the United States. In particular, large Members States like France, Italy, and Spain rank in the bottom five of all OECD countries. Even though Germany ranks above the U.S. overall, it has the sixth highest 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. rate among OECD countries, at 29.8 percent. This is significantly higher than the 25.81 percent combined rate in the U.S.
In reality, this means that four of the largest European economies (and therefore, the EU as a whole) are fundamentally at a disadvantage when it comes to competing with the U.S. for investment. This is not to mention the high regulatory burdens European industries face across the Union that have negatively impacted investment, the higher energy prices due to the lack of a focused energy security policy, and the incomplete Capital Markets Union to better facilitate inter-EU investments.
Focusing on the “threat” to European industry caused by the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act (IRA) rather than internal tax system flaws puts the EU at risk of slower economic growth and possibly losing some of its important industrial base. It is also contrary to the EU’s geopolitical goals.
On one hand, the EU wants to become strategically autonomous in an emerging multipolar world between the United States and China. This implies the EU should have the ability to act independently in important policy areas, like environmental policy and energy security, regardless of the actions of other countries.
On the other hand, there are so many uncompetitive tax systems in the EU that entire industries are deciding whether to pick up and leave due to a decision made by members of Congress in Washington, D.C.
Clearly, this limits the power of European elected officials to create domestic policy consistent with the desires of their voters. It also makes the EU entirely reactionary to policies made by other economic powers. Strategically autonomous and strategically reactionary yield very different outcomes.
Unfortunately, there’s no amount of EU subsidies that will change this dynamic. Nor is there a loophole President Biden can invent in the Inflation Reduction Act (IRA) that will solve Europe’s underlying tax competitiveness problem.
Only European policymakers in Brussels and national capitals can fix this problem, and as the Inflation Reduction Act (IRA) has shown, time is of the essence.Share