With an average tax burden consuming more than 40% of GDP, the 27-member European Union already has some of the world’s highest taxes.
At the same time, the EU faces a fiscal crisis. Most EU countries have huge unfunded liabilities, especially for pensions. Unless EU economies grow at a much higher rate than they have over the last 20 years, taxes will skyrocket as Europe’s baby boomers retire.
You might think that the EU would encourage countries to take steps that can spur economic growth, such as reducing income tax. That’s the approach EU member Ireland took in the 1980s and 1990s. The results were dramatic. While 20 years ago, Ireland was one of Western Europe’s poorest countries, it now has the second highest standard of living in the EU.
But instead of encouraging other countries to emulate Ireland’s example, EU leaders accused Ireland of “harmful tax competition.” And, starting in 2005, it began an initiative to prevent Europe’s savers from escaping the EU’s suffocating taxes.
This initiative is called the EU Savings Tax Directive. Under the directive, EU members have two choices. The choice the EU prefers is to exchange information on the offshore savings of EU residents with their home tax authorities. That way, the home country can tax these savings.
Alternatively, EU members may impose a 20% withholding tax (rising to 35% in 2011) on savings income generated by EU residents. Most of this revenue goes back to the EU residents’ home countries. This option allows EU countries with bank secrecy laws (e.g., Luxembourg and Austria) to comply with the directive without sacrificing confidentiality. Under heavy pressure from the high-tax EU, non-EU members Switzerland and Liechtenstein agreed to impose the tax on deposits from EU residents.
However, the plan has serious flaws, and the EU now has the worst of both worlds: minimal revenues from the savings tax initiative combined with massive capital flight to countries not participating in it—primarily Hong Kong and Singapore. In addition, since the directive only covers interest payments, it's easy for EU depositors to switch to dividend paying stocks or real estate—neither of which is covered by the directive—to preserve financial privacy.
Under the circumstances, the smartest thing the EU could do is to ditch the plan. But instead, it’s planning to expand the Directive. According to the European Commission, the governing body of the EU, amendments will likely include:
- Increase the amount of data exchanged between EU members on accounts held outside a EU resident’s home country
- Increase the number of investments subject to information exchange or withholding, such as life insurance
- Restrict the use of intermediaries to avoid tax by handling interest payments on behalf of EU residents
- Tie in information exchange mechanisms to anti-money-laundering regulations to more easily identify the beneficial owner of accounts.
I predict the expansion of the EU Savings Tax Directive will result in even more spectacular capital flight from Europe. Asia’s offshore havens will boom. And the EU’s high-tax economies will continue to stagnate.
Copyright © 2008 by Mark Nestmann
(An earlier version of this post was published by The Sovereign Society.)
