A Bold Tax Reform Idea

My good friend Michael Tanner, senior fellow at the Cato Institute, has often spoken well of tax and spending reforms in the Baltic states. While we are in some disagreement on the extent to which these reforms have paid off, Tanner is absolutely right in that Estonia, Latvia and Lithuania have shown comparatively strong fortitude in parting with the straight-line statism that holds so much of the rest of Europe in its grip. And he definitely makes a good point in that those countries are good examples for the rest of Europe to follow.

Today, Estonia makes yet another contribution to the debate over what direction Europe should take. In an opinion piece for the EU Observer, the small, proud Baltic nation’s former Prime Minister and former Vice President of the European Commission, Siim Kallas outlines his case against the European corporate income tax:

The European Central Bank (ECB) recently announced it would buy various securities in order to inject more than €1 trillion into the European economy. This move was long expected to counter exceedingly low consumer prices and the euro’s high exchange rate vis-a-vis the currencies of our main trade partners. The European Commission is also developing a €315 billion investment package in the European transport, IT, and energy infrastructure sectors. Both moves can help restore growth in the European economy. But what about structural reforms?

Mr. Kallas is on to something here. Europe’s problems are structural and require far-reaching reforms to so called economic institutions: permanent government spending programs; taxes; regulations that otherwise govern economic behavior. While his interest in institutional – structural – reform is limited to the tax system, it is nevertheless encouraging to see an emerging debate over any part of the European economic structure. It raises the level of attention from the immediate political attention span toward the horizon of tomorrow.

Mr. Kallas again:

Structural reforms have so far been limited to the austerity programmes forced on euro countries with debt and budgetary troubles who couldn’t have avoided default without EU help. They are, understandably, extremely unpopular. At the same time, European businesses, which are, in historical terms, a pro-European force, have voiced frustration over ever-multiplying regulations and shrinking market freedoms. So how about taking some big steps to encourage entrepreneurship and to stimulate the private sector?

Before we continue, it is worth noting that the “European businesses” that Mr. Kallas refers to, have in good part been for the so called European project because it has given them competition-harming legislative influence. Many of the product regulations that have come out of Brussels in the past 20 years have been of such a kind that they have benefited certain businesses at the expense of their competitors. British Member of the European Parliament Nigel Farage often makes this point.

By supporting the “European project”, Big Business in Europe have endorsed a government machine that is now slowly turning on them. The same thing has happened here in the United States, which under the Obama administration has led many large corporate donors to back off from Democrats and other statists. Thanks to our much more dynamic political system, we have already seen the tide turn against big, onerous government.

Europe, on the other hand, is still moving in the wrong direction. Mr. Kallas sees this and definitely understands what the consequences are. Whether or not he can get through to big, lobbying corporations and rally their support – well, that remains to be seen. He seems hopeful, though, and he has a good, tangible idea that could resonate in the right places, namely the abolishment of the corporate income tax. Currently, the political trend is toward so called harmonization of the corporate income tax through something called the Common Consolidated Corporate Tax Base. However, says, Mr. Kallas:

More market-oriented policymakers, especially those in economically more successful countries, fear harmonisation is designed to lead to higher taxes. … Many people say big corporations should make big contributions to national treasuries for political reasons, for the sake of social justice. But perhaps they could make a better contribution by creating jobs and decent salaries. In reality, budget revenues from corporate income tax are moderate due to a mixed set of exemptions and derogations.

A very good point. According to OECD tax data, as a government revenue source the personal income tax is three to five times as important as the corporate income tax. In the four biggest euro-zone economies, corporate income tax revenue varies from 1.8 percent of GDP in Germany to three percent in Italy. British and American corporate income tax revenues claim, respectively, 2.5 and 2.3 percent of GDP.

That is not a whole lot of money. However, the termination of the corporate income tax would leave hundreds of billions of euros in the private sector: if corporate income tax revenue equals 2.5 percent of total EU-28 GDP, then its abolition would allow businesses to keep 330 billion euros more per year. While in the current economic climate they would be reluctant to immediately put all of that money to good use, it would be a major boost to their confidence over time.

Just to illustrate the potential magnitude of a confidence boost: 330 billion euros is approximately 14 percent of total gross fixed capital formation in the European Union. This is equivalent to a $454 billion cash injection into American businesses.

Long story short: Mr. Kallas’s idea is very good. The only problem is that Europe’s consumers sorely lack confidence. Their eagerness to buy what Europe’s businesses produce is not going to go up because the corporate income tax is terminated. That said, if there was an improvement in consumer confidence, the corporate response would be solid and in itself reinvigorate private-sector confidence.

The real kicker here would be a combination of an abolished corporate income tax, a structured exit from the welfare state and tax cuts targeted for households – primarily the VAT. That would most certainly revive the European economy and return the continent to global prosperity leadership.

Mr. Kallas is on the right track. Let’s hope he keeps going and that others join him.