Taxes and the disad­van­tages of small coun­tries in the Euro­pean Union

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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