There are competing perspectives on the relative merits of gridlock. The conventional view holds that a government’s inability to enact new laws promptly and efficiently is indicative of a structural defect. Excessive delay and divisiveness can render government institutions unresponsive to the public’s needs. This feeds stagnation and socioeconomic decline.
The alternative view sees gridlock in more benign terms, perhaps even labeling it a positive influence to the extent that it shields us from the tyranny of the majority. An element of strategically placed blockage can function like a safety brake that nudges us away from impulsiveness and directional extremes. In a gridlocked political environment, only those proposals with the broadest range of support will be politically viable. That encourages compromise and consensus building. Less will get accomplished under such a framework, but those few legislative projects that survive are more likely to prove durable over the long haul.
Such thoughts weigh heavily in political circles these days. Not only in Washington, where a significant portion of the federal government is shut down, but also in Brussels, where EU leaders are contemplating a major shake-up in how the bloc’s tax rules are made.
If recent headlines are accurate, 2019 could be the year in which the EU finally gets serious about eliminating the unanimity requirement for tax directives. The main agitator is no less a figure than European Commission President Jean-Claude Juncker. Were he to get his way, the consequences for EU tax harmonization would be enormous, and the spillover effects would likely shape future tax developments at the OECD level.
This article examines what’s involved in switching from the unanimity requirement to qualified majority voting (QMV). It concludes with a cautionary message: Once sacrificed, fiscal sovereignty is not easily reclaimed.
Indirect vs. Direct Taxation
The EU has been trying to harmonize member states’ tax systems for several decades, with mixed results. There has been plenty of useful coordination regarding indirect taxation. The various VAT directives are proof of that. All 28 (soon to be 27) member states are taxing the consumption of goods and services according to the same basic rules. Still, European VATs aren’t perfect, and their integration is not as seamless as one would hope. If it were, there wouldn’t be so many VAT cases on court dockets.
It’s true that EU officials are revamping their VAT framework — but that’s not a criticism of EU-level harmonization. If anything, it’s a complimentary observation. Without a high degree of coordination, the necessary modernizations would be far more challenging.1
Direct taxation results aren’t nearly as impressive. The European Commission has failed to achieve a comparable level of coordination when it comes to corporate taxation. That’s because of the unanimity requirement of article 115 of the Treaty on the Functioning of the European Union. As one would expect, it’s remarkably difficult to get anything passed when each member state — regardless of GDP or population — has veto power over forward progress.
Over the years there have been a handful of directives affecting corporate taxes. The parent-subsidiary2 and merger3 directives come to mind. But more ambitious projects like the common consolidated corporate tax base (CCCTB) have repeatedly been blocked by dissenting member states. A watered-down version of the CCCTB continues to stumble despite punting on consolidation. Furthermore, there’s still no agreement on how to allocate taxing rights among member states.
Similarly, the unanimity requirement is responsible for the failure of an EU-wide financial transaction tax (FTT), despite widespread public resentment of the banking sector after the 2008 financial crisis.4 More recently, the unanimity requirement featured in the dismantling of the proposed EU digital services tax.5
Any progress in developing a succinct body of EU corporate tax law has often come from the judiciary. Over the last 20 years, the Court of Justice of the European Union has exerted far more influence over the taxation of multinational corporations than the commission. That’s backward when you think about it. The foundational building blocks for something as complex as a pan-European tax regime should originate from bodies like the European Commission and the European Parliament.
A typical CJEU tax decision offers negative guidance. It informs as to what constitutes a technical infringement of EU primary law. It tells government what it can’t do, rather than what it can or should do. Moreover, the docketed cases ask the Court whether national tax laws comply with the four freedoms (the movement of goods, services, capital, and people), which were never drafted with tax outcomes in mind. The four freedoms are rooted in the 1957 Treaty of Rome, yet it wasn’t until the 1990s that anyone thought of applying them to the relationship between governments and taxpayers. The adage that “tough cases make for bad law” is especially true in this context.
Ditching unanimity has been on people’s minds for many years. The rule remains in place for the same reason it was initially included in the predecessors to the TFEU: Taxation isn’t just about raising revenue. Governments always regard tax policy as a vital means of influencing investment, economic growth, and job creation. Right or wrong, elected officials regard their ability to manipulate the tax base as an indispensable component of governance.
The decision to join a body like the EU necessarily involves trade-offs. Member states are required to forfeit sovereignty over a vast range of public functions. The surrender extends to everything from agriculture to transportation to banking and financial regulations. Those member states using the euro give up their monetary policy as well, which is managed by the European Central Bank in Frankfurt. But the last shred of political competency that member states cling to is taxation — or more accurately, direct taxation.
Why the differing attitudes about direct and indirect taxes? The simple answer is that VAT burdens fall on consumption, not capital income. Raising or lowering the VAT rate (or the VAT base) generally isn’t going to discourage capital formation. Countries with attractive VAT rates don’t necessarily attract more foreign direct investment than countries with higher VAT rates. That explains the dominant trend we’ve observed in international taxation over the past 25 years: Corporate rates have gradually declined while VAT rates have gradually increased.
Because VAT increases are less toxic to the business sector than income tax increases, member states are willing to tolerate their VAT regimes being harmonized at the EU level. This implicitly assumes that harmonization eventually leads to upward pressure on tax burdens, not tax relief.
Qualified Majority Voting: An Option?
Juncker went out on a limb during his State of the Union address in 2017, emphasizing the need to eliminate the unanimity requirement. The clearest way to accomplish that would be to formally revise the TFEU itself. That would be extraordinarily difficult. Better would be a workaround based on the existing treaty text. The leading contender calls for using TFEU article 116.6
It’s mildly ironic that Juncker has taken a leadership role on this, given that his fingerprints were traced to the LuxLeaks scandal. Juncker served as Luxembourg’s finance minister and prime minister during many of the years at issue. It’s hard to take him seriously when he disavows any knowledge that corporate tax avoidance was happening under his watch.
Article 116 authorizes the use of “ordinary legislative procedure” when the European Commission determines that adherence to national law results in a market distortion affecting the single market’s competitive alignment. In these circumstances, the EU Council could adopt a remedial directive under QMV with the EP functioning as a joint legislator. Typically, the EP is limited to a consultative role.
QMV requires the approval of at least 55 percent of member states, representing at least 65 percent of the EU population.7 After Brexit, the 55 percent threshold would be satisfied by the assent of 15 of the remaining 27 countries. That allows for the Council to approve tax measures over the objections of a dozen member states — a far cry from the status quo in which a single holdout can block advancement.
The article has never been used in this manner, and its application would be controversial. Some member states would bring legal challenges, with the CJEU having the final say. A preliminary question is determining who must identify the market distortion. The EU has both a tax commissioner (Pierre Moscovici) and a competition commissioner (Margrethe Vestager). Nobody is sure who between them must function as the pro forma declarant, and the two might disagree on the matter. The burden of proof is also unsettled. How much hard evidence would be necessary to establish that (i) a market distortion exists, and (ii) the distortion is attributable to differences in national tax laws, as opposed to other factors? Nobody seems to know the answer to these questions.
The exercise seems to call for a type of comparability analysis between the actual EU tax regime and a theoretical baseline that’s free of distortion. It’s unclear how that baseline would be determined. Identifying the distortion and establishing causality could be a high bar in terms of evidentiary burdens. On the other hand, plain vanilla behavioral responses shouldn’t be hard to identify. All taxes discourage something, just as all tax abatements incentivize something. If the bar were set too low then ordinary procedure would be commonplace. Reform advocates need to determine whether QMV should apply across the board, for every tax proposal that comes before the Council, or be limited to the occasional large-scale projects where market distortions stand out like a sore thumb.
Going to the trouble of invoking article 116 and then losing the resulting CJEU litigation would be a fiasco. Juncker wants to avoid a repeat of the Schneider Electric debacle.8 These concerns are serious enough that legal advisers to the commission have expressed caution. A backup plan would rely on TFEU article 48.7, which authorizes the EU heads of state to adopt QMV on a case-by-case basis. The difficulty there is that the decision to drop unanimity must be agreed to by each head of state — which seems impossible despite Juncker’s negotiating acumen. If it requires unanimity to ditch unanimity, nobody has gained anything.
The fact that Juncker and Moscovici are pushing for QMV continues to irritate those member states that have used their veto power to derail prior harmonization efforts. This group includes Ireland, which is convinced its business-friendly tax environment has significantly contributed to the country’s economic boom. Ireland’s corporate rate of 12.5 percent is among the lowest in the industrialized world, and there’s not much discussion of increasing it. I can’t imagine a situation in which Ireland agrees to QMV for taxes.
The latest developments convey a strange sense of urgency. On December 21, 2018, the European Commission released a roadmap for moving away from unanimity. The materials describe the current voting procedure as “an obstacle to efficient decision-making.” Interested parties have until January 17 to submit their responses. The timetable seems short for an issue of such magnitude. It’s roughly a month and overlaps with the festive period and the United Kingdom’s Brexit drama. It’s as if the commission hopes the matter passes under the radar while the media’s attention is focused elsewhere. A communiqué on the topic is expected in the first quarter of 2019.9
There are signs Juncker may link QMV expansion to the “own resources” discussions. The expectation is that revenue contributions will decline after Brexit, and the bloc’s multi-annual financial framework will need adjusting to close the gap. Expanding QMV to taxation could help grease the wheels for the introduction of new revenue sources.
Separately, French President Emmanuel Macron has suggested that future access to EU structural funds could be linked to a country’s respect for the rule of law, including fair tax competition.10 His comments didn’t mention the unanimity rule, but one interpretation hints that those opposing harmonization of corporate taxes could be starved of financial resources in the future.
In Praise of Gridlock
Where would we be today if the framers of the TFEU (and its predecessor treaties) had never insisted on the unanimity requirement? What if the EU had operated on QMV from its inception?
One suspects the tax world would look a bit different, though not necessarily better. Under that scenario, we might expect that Europe’s corporate tax regimes would be just as harmonized as their VAT regimes. The CCCTB would be a teenager by now, having sprung to life sometime in the early 2000s. The formulary allocation of taxing rights under the CCCTB would probably cause the arm’s-length standard to be viewed more skeptically (if that’s possible). Residual profit splits might be viewed less harshly.
There would also be an EU-wide FTT born in the aftermath of the 2008 financial crisis. An FTT might have taken the edge off the austerity programs that followed the crisis and softened the populist backlash. We might also have an EU-wide digital services tax up and running, at least as an interim measure until the OECD settles on an acceptable long-term solution.
On the other hand, life under QMV might have negated the necessity for the base erosion and profit-shifting initiative. Although operated by the OECD, the BEPS project was driven by a few large EU member states. If the concerns of those countries were adequately addressed by directives coming out of Brussels, then there would have been less impetus for BEPS-type reforms in the first place. Depending on how far one is willing to stretch our logic, one could argue the unanimity requirement is indirectly responsible for the onset of country-by-country reporting, the multilateral instrument, and everything else contained in the BEPS minimum standards.
The purpose of the hypothetical is to underscore a point. For better or worse, we live in a world divided into nation-states. The more powerful among them have the means to make their voices heard — diplomatically, militarily, and economically. Smaller countries lack that ability. They are left to search for isolated pockets of leverage, where they can hope to exert influence if they’re lucky. Such opportunities are limited, but participation in multilateral bodies enables smaller countries to punch above their weight.
If that balance of power is a desirable outcome, then policymakers shouldn’t assume legislative efficiency is the only standard by which to judge things. The benefits of tax harmonization are real, but one senses they’re being oversold to suit the interests of larger EU member states with little to lose in terms of competitive advantage.
FOOTNOTES
1 See Robert Goulder, “Building a Better VAT: Europe’s Big Risk,” Tax Notes Int’l, May 7, 2018, p. 805.
2 See Council Directive (2011/96/EU) of November 30, 2011, on the common system of taxation applicable in the case of parent companies and subsidiaries of different member states.
3 See Council Directive (2009/133/EC) of October 19, 2009, on the common system of taxation applicable to mergers, divisions, partial divisions, transfers of assets, and exchanges of shares concerning companies of different member states.
4 In 2014 a subset of EU member states agreed to adopt a modified version of the FTT under the enhanced cooperation procedure.
5 See Stephanie Soong Johnston, “Time for an Update: The Digital Economy Tax Debate in 2019,” Tax Notes Int’l, Dec. 24, 2018, p. 1274.
6 See Elodie Lamer, “Is the End Near for the Unanimity Rule for EU Tax Issues?” Tax Notes Int’l, Sep. 25, 2017, p. 1232.
7 See William Hoke, “Moscovici Eyes Qualified Voting on Tax Matters,” Tax Notes Int’l, Dec. 11, 2017, p. 1039.
8 See Lamer, “MEPs Looking at Ways to Assert Themselves on Tax Issues,” Worldwide Tax Daily (Nov. 17, 2017).
9 See Lamer, “Tax Sovereignty Will Be a Top EU Issue in 2019,” Worldwide Tax Daily (Dec. 31, 2018).
10 See Lamer, “France Seeks to Link Fair Taxation, Access to EU Funds,” Worldwide Tax Daily (Feb. 23, 2018).
END FOOTNOTES