Charlie McCREEVY
European Commissioner for Internal Market and Services

Tax harmonisation - No thanks

European Business Initiative on Taxation
Brussels, 10 November 2005

Good morning Ladies and Gentlemen:

Thank you for inviting me to speak here today.

Throughout my near 30 years in political life my main focus has been on economic issues-on advocating policies that in my view would contribute towards improving economic performance. During the first half of my political career the Member State from which I come was over-taxed, over-regulated, over-borrowed, under-invested and quite poor. In the past decade that position has been completely reversed. It didn't happen by accident. It happened by putting together a package of policies that are as relevant today to the task of economic transformation as they were a decade ago: Investment in education and retraining, an attractive fiscal environment, good infrastructure, sound corporate governance, light touch regulation, social partnership, market liberalization and competition.

For governments, successful economic policy is of course not an end in itself: It is a means to other ends - towards creating educational and training opportunities for those who would otherwise be deprived of them, to getting people into work and off the dole queues, to creating the resources for funding healthcare and retirement and looking after the disabled. And a means for funding collective goods and services- like defence and security- that the market alone can never realistically provide.

Wealth creation through entrepreneurship will always determine a country's capacity to make social progress. Social provision is the by-product of tax generation and tax generation is the by-product of wealth creation. Wealth creation in turn is the by-product of entrepreneurship, risk taking and investment. You can't have one without the other. Nor can you have one before the other. The capacity of well intentioned people to get these things back-to-front is amazing.

Since entering politics I have fought against the notion -once widely held in my own Member State and still widely held in some others - that the way to improve educational standards, to advance social programmes, to enhance social inclusion and to provide good security and infrastructure, is to throw money at them by loading a nation's entrepreneurs, companies and workers with more and more taxes at higher and higher rates. And to impose on them more and more regulations that reduce their flexibility and diminish their freedom to innovate, invest, and grow.

I am not the best of workers in the kitchen. But my wife once asked me to whisk some eggs for a soufflé. Never an enthusiast for kitchen implements, I surprised her by taking to the egg beater with gusto. After a few minutes she told me that the eggs should be lightly whisked. If I didn't stop, the soufflé wouldn't rise in the oven - or if it did, once I took it out of the oven it would quickly collapse.

Entrepreneurs are to an economy what eggs are to a soufflé. Properly whisked, they are the agents that lift economies and make them grow. But an economy with over-beaten entrepreneurs is like a soufflé with over-beaten eggs: They fall flat on their face.

Politicians and policy makers- wherever they are- seeking to create a good, robust, social model must be like cooks in a kitchen seeking to create robust, tall, and tasty soufflés.

They must mix the ingredients in the right way, in the right order, and in the right quantities so that the end-product is robust. Mix tax, spending and regulation into an economy in the wrong order or beat its entrepreneurs and over-burden them with too much tax and too much regulation and like the soufflé, the economic model will collapse.

In the world in which we live, with competition intensifying for everyone, every tool and every ingredient that can help Europe's Member States to improve their competitiveness and sustain social and economic progress must be used.

One of the tools and one of the key ingredients in the competitiveness mix is taxation.

It is neither sensible nor realistic to seek convergence of tax rates across Europe. Different Member States have different demographics, different social programmes, different sources of competitive advantage. Therefore they need to use taxation in different ways and in different doses to achieve their economic and social objectives. That's just one reason why harmonization is off the agenda. There are many others.

But while it is easy to oppose harmonization by the front door, we must equally guard against its arrival through the back door. We must always remember that centralised prohibitions from Europe on specific types of taxes have the potential to force governments reliant on those types of taxes to replace them with other, maybe less enterprise friendly fiscal measures.

The same would apply if we were to standardize deductions and allowances.

The Commission has started preparatory work on harmonizing the corporate tax base across Europe with a view to aiding simplification for pan-European companies and investors.

It is not an area where I have direct responsibility in the Commission although as a Member of the Competitiveness Group of Commissioners I have a keen interest in the role that a sensible taxation environment can play in enhancing Europe's economic prospects.

I didn't come to the Berlaymont to tiptoe about in my slippers.

I do not believe either in walking down the corridor with a blind fold on, muffins in my ears, or a muzzle on my mouth. If I sense there are potholes ahead, I want to spot them before I walk into them - and point them out to others.

So lets consider the proposal for a harmonised tax base in this light.

Lets face facts. First, it is inevitable that any exercise involving tax base harmonization will have winners and losers. Those winners and losers will be determined by the basis on which the cake is divided or in other words how the allocation of a company's pan-European profits across the Member States is broken down for the purposes of levying the tax. The major challenge is to determine what criteria are used for determining the size of each slice of the cake. And should the criteria differ from industry to industry?

Just think about it.

To establish a common tax base we will need first to get agreement on what constitutes taxable profits. At the moment there are wide divergences between Member States- in terms of what interest expense is tax deductible and what isn't, what capital spending is allowable and what isn't, over what period assets can be depreciated and what depreciation is allowable and what isn't, how and when income is recognised in different circumstances for tax purposes, to what extent and in what circumstances tax losses can be carried forward and for how long. I could go on and so could you.

One can see immediately the huge task of agreeing technical details between 25 different Member States - some where a broad accounting approach is used and where there is relatively close proximity between accounting profits and taxable profits, and others where there is a much more remote relationship between accounting profits and taxable profits.

Assuming we can agree on all of these things across all 25 Member Sates at some stage during our lifetimes, we will probably then have completed one third of the journey to the harmonized tax base. The harder bit comes next. That's the bit where we have to face the thorny issue of how much profit is allocated to each of the 25 Member States with which each company trades. For some companies, the true source of their profits lies in the strength of their brands. For others, it lies in the strength of their patents, in their success in innovation, in the rights conferred by their licences, in the nature of the annuity streams from their customers, in the scale, quality and efficiency of their fixed assets, in the domicile and nature of their risk assets, or in the strength of their supply chain or their distribution system. These things and the value they add- or subtract- in absolute terms and in relative terms will differ from Member State to Member State and from company to company. But it will surely take a serious combination of intellectual genius, political skill and commercial acumen to find a one size or even a one hundred and one size fits-all formula that all Member States can sign up to, to break down the different parts of each value chain and to determine what value has been created where. And then, to move on from that to create a formula that will determine what profits should be allocated to which Member State- a formula to fit the circumstances of every type of company involved in every type of activity across every Member State.

I trust you can see that the abandonment of the current "separate entity" approach for companies operating across the EU and substituting it with a consolidated aggregate taxable profit figure to be arrived at for all of a multi-national's subsidiaries and branches operating across the Member States will be a real challenge. And maybe for some of you a great fee generating opportunity!!

Lets look at some of the possible routes:

Take the notion of allocating profits on the basis of the domicile of a company's asset base. What would you include as an asset? How would you value the intangibles? I am not sure that even the world's brand leaders have resolved the many thorny accounting issues surrounding brand valuation. But can you really ignore the value of brands for determining the source of profits when so much of so many companies' value added is based on them and so many companies' pricing power is determined by their strength. In our increasingly intangible, service-based economy intellectual property rights, brands and other intangibles often make up 90 per cent or more of a company's real assets.

What about employment levels as the yardstick? The trouble with this is that there may be very little correlation at all between employment share of a pan-European business in one Member State and its value added in that Member State. The quality and productivity of the employees and the part they play in the value chain will be much more important factors.

It is of course easy to identify the problems -much more difficult to identify the solutions. I am not going to anticipate what progress will be made on advancing the consolidated tax base idea.

My colleague Lazlo Kovacs i has been making excellent progress with a whole series of proposals for simplifying and easing the burden of administration of tax and customs obligations for companies operating across Member States. I believe that this will make a meaningful contribution over time towards reducing the regulatory and cost burdens for businesses trading across borders.

But let me reiterate that I am emphatically opposed to tax harmonization - be it by the front door or the back.

Nor does the Commission as a whole believe that levelling up tax in the direction of harmonization offer any solution to the problems now confronting Europe.

Recent events in Europe are giving rise to concern. Tension is rising in Member States where unemployment is highest and sadly this has most recently culminated in violence. Social cohesion is important. Making every citizen feel valued and included in the Member State in which he or she lives is important. I have always held the view that the best route to social inclusion is sustainable employment. And the best route to sustainable employment is flexibility, freedom, competition, light touch regulation, and low taxation- in labour markets and capital markets alike.

I know people will ask: How can you get taxes down if unemployment and dependency is going up?

First, you must create the conditions for workers- through, where necessary, re-training, re-education, and relocation- that will enable them to move from dependence to independence.

Second you must create the conditions for businesses to change and grow and take on more people. Culling regulation that increases the cost of employing labour or that slows adaptation to rapidly changing markets is key in this.

And third, you must stop funding inefficiency-

It is the same handful who resist more open markets for public procurement that would give their taxpayers better value for money, that resist more competition in services that would bring down their cost, that resist free movement of capital that would see new investment inflows, that resist changes to labour practices that would facilitate quicker responses to more competitive markets. In practice these people are in the cause of protecting existing jobs that destroy wealth. In practice too- because of the misallocation of resources towards sustaining inefficiency - they are also in the service of destroying opportunities and preventing the release of capital for new, more durable, and better jobs - jobs that create wealth, give people independence, generate tax revenues, and sustain self-financing employment. Those who stand in the way of reform stand in the way of that virtuous circle.

Ladies and Gentlemen, as a politician I hope I have always understood human weaknesses and human fraility and that politicians fall victim to them as much as anyone else. I understand too why soft options often appear more seductive than hard choices.

But sometimes in politics, the wind changes Sometimes the appetite is there for strong leadership and hard choices. Electorates who vote in politicians and vote them out don't usually spend much time thinking about politics or political issues. They are, in the main, far more pre-occupied by their families, by their jobs, by football, or by the various vices in which most of us, to a greater or lesser extent , indulge.

But people do respond to courage and to leadership. They don't have to love politicians to vote for them. But they do have to respect them. If you look around the world there are many instances of politicians who spelt out the hard truths to their electorates and won while those who advocated the soft options lost. I believe the same will happen in Europe in the years ahead. Of one thing I am certain, taxation will remain at the centre of debate - both within Member States and between them. Tax harmonization is not on the agenda, nor will it be. National vetoes will be retained and competition between Member States for attracting inward investment - some of it tax based - will continue. Tax competition is a healthy spur to governments across Europe to manage their public finances carefully and to build and sustain a tax regime that encourages enterprise, creates jobs, boosts living standards, and restores growth.