The EU Tax Myth: The Unrealistic Hope for an End of National Egoism

The idea to finance the EU budget through an EU tax in the future is one of the prominent reform proposals for the next financial framework for the years 2014-2020. Its proponents demand that better sooner than later the Union should be financed through a true own resource which should replace the de facto contributions from the member states. An EU tax competency can be assessed along different criteria. For example, it is a legitimate discussion whether an EU tax could be a reasonable way towards the harmonization of a particular tax for which harmonization arguments outweigh advantages from tax competition. Another important argument is that European actors with spending responsibility should also have revenue responsibility for reasons of fiscal equivalence.

However, one particular argument deserves closer attention because it is so frequently put forward in favor of an EU tax: An EU tax could overcome the net return preoccupation of member states and their view on the EU budget. This argument is highly present in Brussels debates on the EU budget and there is some, at least partial, support from academia.[1] In this view, true own resources would stop member states from focusing on the net balance from payments to and returns from the EU budget. As a consequence, the way would be cleared for moving the budget towards the financing of true European public goods. Hence, according to many proponents, an EU tax is a precondition for putting an end to the distorted national view on the budget and the regular political trading on programs with substantial national backflows.

How valid is this argument? First of all, this view is based on the correct identification of a key problem. Indeed, the EU budget suffers heavily from the member states’ lack of interest in European public goods. Instead, national actors use their political influence to lobby for programs with visible fiscal flows towards their own countries and constituencies. If, with scarce budgetary resources, there is a conflict, e.g. in external policies, between a European task on the one side and a structural fund program for the benefit of the home constituency on the other side, national politicians regularly opt for the national program. One example: Currently, walking paths in the Berlin Tierpark are renovated using EU structural fund resources. Such a visible EU gift is of much higher political utility for German politicians than an aid package for North Africa – although walking paths in a German park are anything but a European public good.

Although this problem analysis is appropriate, the view that those political preferences would change with a new structure for the revenue side of the budget is unconvincing. In the public finance and political science literature the causes for the local spending bias have been well known since the path breaking contributions from Kenneth Shepsle and Barry Weingast in the early 1980s. What is crucial for this bias is the asymmetry between the spending interest of a local representative and the financing from the large common revenue pool which comprises the jurisdiction as a whole. The bias of budgetary decisions of local representatives is the consequence of an externality: From the perspective of local voters and representatives, the costs of local programs financed from the central budget are largely external. Hence, the demand for these local programs is above the optimal level. It is obvious that this common pool problem should be particularly severe for the EU budget even compared to national budgets: In the case of the EU budget, the common pool of revenues comprises revenues from 27 national states. From the perspective of (smaller) EU countries, a structural fund program or an agricultural subsidy from the EU budget is perceived to be practically cost-free.

While this problem analysis is straightforward, the related optimism of EU tax proponents is hard to understand. A substitution of national contributions by a direct European tax does nothing to eliminate the common pool problem. This new way of financing would not lead to a stronger cost share of member states or regions for EU spending programs. The EU-financed program would still be an excellent deal from the perspective of the recipient member country. Why should national government then lobby less aggressively for EU programs benefitting their country if an EU tax is introduced? Why should walking paths in the Berlin Tierpark suddenly be of less political appeal compared to aid for Northern Africa just because the EU financing share is now financed through a tax? For these questions, any convincing answer is lacking.

Depending on the specification of the EU tax, it might even be the case that disincentives deteriorate. This holds in particular if the new own resource lacks transparency and the new revenues would come from a “black box” in the perception of voters. Examples are a financial transaction tax, an EU corporate income tax or the suggestion to finance the budget from the proceeds of CO2 emission trading. With all these own resource options, the major share of voters would have no idea about the material incidence of these revenue sources. It is well possible that, as a consequence, national governments would cease to be interested in the financial burden of the budget. But they would continue to do everything to direct as much EU spending as possible to their home countries.

In this case of new resources with low voter transparency, the one-sided “net-return-perspective” would then be replaced by an even more distorted “return-perspective”. Nothing would be gained. Quite the contrary, the stronger limitation of the national perspective would even deepen the common pool problem and its underlying asymmetry: On the expenditure side, the political usefulness of national and local spending programs would go unimpaired.  Its political costs would even fall as a consequence of lacking revenue transparency. This would be an invitation to a further inefficient expansion of the budget for the benefit of programs with high national and local visibility.

What would be the alternative towards a rational financing system for the EU budget? The following two approaches are clearly superior since they precisely target the underlying common pool disincentives. First, the national financing share of EU programs should increase. Agricultural subsidies like market support and direct income support are currently fully financed from the EU budget. A national co-financing would be a first step to a more rational national analysis of this anachronistic subsidy. Second, a clever design of an EU budgetary rebate could neutralize disincentives. If a generalized correction mechanism taxes away the national fiscal advantages from EU financed policies, the interest in those programs would decrease. [2]

There might be other more or less convincing arguments in favor of an EU tax.[3] However, the argument which claims an end of national egoism in the EU budget lacks any consistent foundation. Hence, proponents of the EU tax should finally eliminate this untenable argument from their justifications.

[1] A typical joint position of politicians and academics along these lines is: Jutta Haug, Alain Lamassoure, Guy Verhofstadt, Daniel Gros, Paul De Grauwe, Gaëtane Ricard-Nihoul and Eulalia Rubio (2011), Europe for Growth, for a Radical Change in Financing the EU. CEPS, Brussels.

[2] One specific proposal is the generalized but limited correction mechanism: Friedrich Heinemann, Philipp Mohl and Steffen Osterloh (2008), Reform Options for the EU Own Resource System. Physica, Heidelberg.

[3] For a discussion of the pro and cons of an EU tax see: Steffen Osterloh, Friedrich Heinemann and Philipp Mohl (2008), The EU Tax Revisited: Should There Be One? And Will There Be One?, Journal for Comparative Government and European Policy 6 (3), 444-475.

Friedrich Heinemann

About Friedrich Heinemann

Friedrich Heinemann is head of the department "Corporate Taxation and Public Finance" at the Centre for European Economic Research (ZEW) in Mannheim. He received his Ph. D. ("Dr. rer. pol.") from the University of Mannheim. His doctoral dissertation dealt with the "Financial Constitution and Competencies of the European Union after Maastricht". 2010 he received his postdoctoral degree (*Habilitation*) from the University of Heidelberg and the Venia Legendi for economics. His research is devoted to empirical public finance with a particular focus on the EU budget. Heinemann teaches at the University of Heidelberg, is board member of the Arbeitskreis Europäische Integration, member of the Scientific Board of the Institut für Europäische Politik (IEP) and Fifo Policy-Fellow.