Taxes and the disadvantages of small countries in the European Union

EU membership has many advantages for Cyprus – otherwise we would not have joined. But the EU is changing. With the i mpending withdrawal of the UK from the European Union, the motivation toward closer integration has gained additional impetus. There is now serious talk about a European defence force and closer integration in other areas, particularly taxation. This movement brings with it certain disadvantages, especially for the smaller countries of the EU, such as Cyprus. It is well to anticipate such change in order to prepare a response.

In a recent article in the Financial Times, the prime minister of France set out his vision for the future direction of the EU. He wrote: “Member states must progress toward common European tax rates”. This should surprise no-one. The European aim of a single market strongly suggests the removal of national differences such as preferential taxes and regulations. His statement was quickly followed by a report stating that the European Commission will propose legislation for a “Common Consolidated Corporate Tax Base”. The immediate concern is that this will be directed at raising the Irish corporate tax rate of 12.5%, which the European Commission has previously tried to revise upwards. If the Irish tax is increased, can pressure on Cyprus to raise its corporate tax rate (also at 12.5%) be far behind?

Cyprus has already had a taste of the movement toward tax uniformity. Following the recent financial crises, the Eurogroup required Cypriot corporate taxes to be increased from 10% to 12.5%. Taxes on dividends from Cypriot companies were tripled, from 10% to 30%, moving, here again, toward uniformity with other member states. This seems fair. If greater equality is the result, one may ask: what is the problem?

The great success of the European Union has been to make possible the relatively free movement of goods and services across national borders. But as regards investment and production, there are still major barriers in the form of institutional, cultural and geographic discontinuities between member states which hinder the ability of small countries to compete in certain industries.

Due to their small size and transport costs, countries like Malta and Cyprus (for example) are unlikely to be able to compete in many of the industries which underpin the economies of larger EU countries. These smaller countries cannot compete across a whole host of industries which require large scale production to make their costs competitive. These include major industries such as steel, aluminium, aircraft production, television, automobiles, computers, etc.

Since research costs are highly sensitive to such economies of scale, this exclusion is also likely to include many industries on the frontiers of science, such as genetic engineering, new medical drugs, atomic power, aerospace, etc.

The disadvantage of small size also applies to service industries. With a tourist population of 3 million, Cyprus is not able to match the advertising expenditure of France with its annual tourist arrivals of some 85 million.

In the past, these disadvantages were countered by advantages smaller countries were able to offer foreign investors and local industry in the form of tax breaks and certain regulations.

These are now threatened in the name of equality. Of course, individual citizens, interested to develop or find employment in such industries are able to emigrate to one of the larger EU countries. This solves the problem for the individual but only exacerbates it for the country which has lost that person’s talent and expertise. Small countries have seen thousands of their citizens, which they have spent considerable sums to educate, moving to their larger neighbours to find industries which match their talents and career objectives.

In short, EU integration can remove tariffs and other barriers but it cannot remove the sort of barriers which limit the business opportunities open to small countries. Historically, these countries have compensated by implementing lower levels of taxation and different regulations. Losing them would amount to a serious economic set-back.

Ireland was able to keep its low 12.5% tax (the same as ours) by strongly opposing several attempts by the EU to change it.

The change proposed by the European Commission means it will not be long before Ireland is called upon once again by the EU to raise its corporate tax. Ireland will oppose this. Success is in doubt. In the past, Ireland received support from the United Kingdom which has been a strong opponent of a common EU tax regime. Brexit means this support will no longer be forthcoming.

Other small countries should take notice and join with Ireland in opposing the EU tax initiative. Better still, small EU countries can join together as a lobby to present and forward their particular interests within the EU. If the Irish corporate tax is raised it will not be long before Cyprus is asked to “fall in line”.

Other measures besides taxation can help small countries attract those industries which can operate effectively in a small country.

Cyprus, in particular, should intensify efforts to make itself more attractive as an investment location by simplifying and speeding the many bureaucratic processes that often encumber applicants who want to invest here. Foreign investors consistently complain about our bureaucracy and red tape.

The truth of this is reflected in the many investment opportunities lost to Cyprus, such as the Chinese investor who indicated a desire to make a massive investment in the old Larnaca airport, but who was eventually discouraged by the many delays and obstacles.

Singapore takes advantage of this sort of weakness by offering speedy and efficient service to new businesses. An application there to start a new business can be processed in just two or three days.

Unfortunately changing anything connected with the public service seems to be hopeless in the case of Cyprus. But miracles do sometimes happen.