EU: The Next Generation

Today, the European Commission announced new budget plans including loans, grants, and some revenue offsets. The proposals follow other support mechanisms for workers and businesses that were designed in response to the Covid-19 pandemic and economic shutdown.

The Commission is adjusting its work program for 2020 to “prioritize the actions needed to propel Europe’s recovery and resilience.”

A major piece of the new policy approach is a €750 billion set of programs referred to as “Next Generation EU.” That program will have three pillars focusing on:

1. Supporting member states to recover
2. Kick-starting the economy and helping private investment
3. Lessons from the crisis

Within each of these pillars are multiple programs with different (and sometimes overlapping) aims for support and recovery. The European Commission’s vision is for these programs to last from 2021-2027 as part of the EU budget.

Financing the Next Generation

One piece of what was released today is a reminder of some tax proposals that remain on the EU agenda.

The four proposals include:

1. Extension of the Emissions Trading System (€10 billion per year)
2. Carbon border adjustment mechanism (€5 to €14 billion per year)
3. New taxes on “operations of companies that draw huge benefits from the EU single market” (€10 billion per year)
4. Digital services 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. (€1.3 billion per year)

Taken together, the proposals could raise up to €34 billion annually for the EU’s own budget (as opposed to revenues for individual countries), a 23 percent increase over 2018 revenue levels.

Emissions Trading System

The Commission is proposing to extend the Emissions Trading System (ETS) to both maritime and aviation sectors. The ETS is a cap and trade program that has been part of the EU’s climate policy since 2005 and is operable in all EU countries as well as Iceland, Liechtenstein, and Norway. Currently, the policy covers 45 percent of the greenhouse gas emissions in the EU. Expanding the ETS to cover the maritime and aviation sectors is part of the EU’s commitment to implementing its new green agenda.

Carbon Border Adjustment

Another environmental policy which would raise revenue for the EU budget is the carbon border adjustment. The EU ETS effectively increases the cost of using carbon-intensive production within the EU, but it does not prevent businesses from importing goods that have been produced elsewhere and are not subject to the ETS. To treat both domestic and foreign production equally, a carbon border adjustment would work to tax the carbon content of imports. However, the policy faces some design hurdles since it could work like a tariff and run afoul of the World Trade Organization.

CCCTB or Something Else?

The next tax proposal is rather vague and could potentially be the most significant change to the structure of tax systems throughout Europe. It is likely that the Commission is referring to the policy of a Common Consolidated Corporate 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. (CCCTB) which would apply to multinationals operating in the EU with more than €750 million in annual revenues. The policy itself would change the taxation of multinationals throughout Europe, and the EU budget would take a slice (around 3 percent) of the tax revenue under the proposed policy. Calculations from the European Court of Auditors published in 2018 suggest this approach would raise €12 billion for the EU budget annually rather than the €10 billion number mentioned in today’s release.

Various versions of the CCCTB have been in development since 2011, and the proposal could continue to languish in legislative limbo.

However, it is possible that the policy envisioned by the European Commission in this area is something other than the CCCTB. A Dutch news outlet reported that the €10 billion would be raised using a 0.1 percent tax on the gross revenues of multinationals with more than €750 million in annual revenues. A new turnover tax of this nature would be incredibly bad tax policy and could undermine the recovery aspirations of European policymakers.

Taxes should be on net income rather than revenues, otherwise the policies do not distinguish based on measures of ability to pay, like profitability. Europe abandoned turnover taxes in the 1960s in favor of Value-added Taxes because of the negative economic effects of taxing revenues rather than profits (or in this case, value added). Policymakers should be wary of any tax that can raise significant revenue with a rate so low as 0.1 percent. That is a signal that the tax is poorly designed, and in the case of turnover taxes, that design would have serious negative effects.

Digital Tax

The Commission also specifically targets digital businesses with more than €750 million in annual revenues. Similar to the previously discussed policy, the digital tax could either be a version of the European Commission’s 2018 digital services tax (DST) proposal or something else entirely.

The 2018 proposal would tax the gross revenues of certain large digital companies at 3 percent. The proposal is both distortionary because it would tax turnover rather than income and discriminatory because it would tax digital companies under rules that would not apply to other industries.

That proposal was estimated to raise €5 billion annually, which is considerably more than the €1.3 billion mentioned in today’s release. However, several iterations of the DST have been discussed, and it is possible that a slimmer version of the DST is what the European Commission has in mind.

More to Come

The European Commission clearly has more work to do to add detail to the tax pieces of their new proposals and that is before taking up the political challenge of turning them into EU law. The proposals all have some potential downsides, and EU policymakers should carefully review their impacts. It will be difficult to develop a European recovery around a system of taxes that works as a barrier to growth and investment. Unfortunately, it seems that pro-growth tax policy is not on the agenda.

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