Local and International Businesses Take a Hit as EU Pressures Andorra to Enact Income Taxes

June 6, 2013

Nestled in the heart of the Pyrenees mountain range, between France and Spain, rests the small nation of Andorra. Known primarily for its tourism industry, Andorra faces threats from the European Union and OECD. Unless they act to comply with international tax standards, the EU warned, they would be placed on a blacklist.

What has Andorra, with a population of 85,000 people, done to raise the ire of the EU? They are one of the few nations in the world that has maintained bank secrecy laws and not levied income taxes on residents. Andorra has previously relied on registration fees, property transaction taxes, and minor sales taxes to generate revenue. This tax climate has drawn investment into the Andorran economy which the EU cannot reliably track because of Andorra’s bank secrecy policies. These policies have caused Andorra to be labelled as a tax haven. The EU, which loses $1.3 trillion a year in tax evasion, intends to bring tax havens into compliance with international standards by requiring them to levy income taxes and share banking data. This will decrease both the incentive and the ability for people to move their money into Andorran banks.

Refusal to comply with EU pressure would be economically and politically costly. The French budget minister, Eric Woerth, declared that noncompliance would result in placement on the OECD’s blacklist of uncooperative tax havens. Blacklisted nations face being ostracized by the EU, as well as higher international dividends and capital gains taxes.

Andorran prime minister Antoni Martí met with the President of France in response to the threat. Their discussion culminated in Martí’s promise to introduce an income tax on residents before June 30th in order to avoid blacklisting. Although a tax rate has not been decided, officials have agreed that both a personal and a corporate income tax will be enacted.

This news comes as a blow to the Andorran economy, as it will add additional burdens to the already struggling tourism industry. Tourism represents nearly 80 percent of the economy and has seen significant turmoil over the past several years. The financial crisis of 2008 directly impacted Andorra as people cut back on vacationing to save money. As a result, the tourism industry has shrunk by 25 percent over the past decade. This trend can be expected to continue as tourists see higher prices as a result of the taxes.

More importantly, new taxes will place additional financial strain on local and international businesses. Research has shown that corporate taxes have a negative impact on investment and productivity. The elimination of an income tax free zone and introduction of a permanent corporate tax will diminish the incentive for international corporations to invest in Andorra. Perhaps the most significant impact, however, will be on local businesses who face permanent corporate taxation for the first time in the nation’s history.

Andorra’s economy will likely continue to struggle in the upcoming years as a result of the EU-induced policy changes. The toll of slower tourism, the housing crisis, and increased taxation has already caused the economy to contract by roughly 12 percent. Piling taxes on individuals and businesses will only exacerbate the problem by causing higher unemployment, higher prices, and diminished productive activity.

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