Blair skates on Vienna's thin ice

FROM the eve of the European summit, when socialist leaders dined in the neo-Gothic splendour of Vienna's Rathaus, agreement was rarely at hand. A lengthy plea for a reprieve for duty free sales from the German Chancellor, Gerhard Schroder, came to an abrupt conclusion when the Dutch prime minister, Wim Kok, abruptly changed the subject.

The exchange was typical of a two-day meeting where progress was slow and breakthroughs few and far between. After a torrid three weeks of Eurosceptic pressure, the summit was not the disaster for Mr Blair some had predicted. But as leaders left the snowbound city, the talks pointed to areas of difficulty for Britain.

The first and most sensitive is Britain's budget rebate, worth on average pounds 2bn a year. Enshrined in treaty, it cannot be changed without government agreement. But it faces reform. It lies at the heart of the EU's hottest topic of debate - Germany's determination to end its status of bankroller-in-chief to the EU.

It was clear, before the German elections, that any new government would demand cuts in contributions. Bonn is by far the biggest paymaster to the EU, a net contributor of pounds 8bn a year and the source of 28 per cent of the budget. But Germany's claim for a reduced contribution has taken observers aback for its new, aggressive tone. In one speech last week, Mr Schroder said his predecessor, Helmut Kohl, had been "ripped off", in another he said Europe's problems could no longer be solved via Bonn's chequebook.

One answer, which Germany, France and Britain back, is to freeze spending at current levels. But Spain, in particular, has proved obdurate - such a move would slash the structural and cohesion funds. And in Germany there is little sympathy for a country that thinks itself economically successful enough to share a currency, yet demands huge subsidies.

But since the negotiation of Britain's rebate, in 1984, circumstances have changed. Four other countries, Germany, the Netherlands, Sweden and Austria, now complain that they are in a worse position than the UK of the mid-1980s. The rebate may escape the 2000-2006 budget round, but the European Commission's view is that it cannot continue as it is once the EU enlarges.

Yesterday, Mr Blair, for the first time, said Britain would pay its share.That points to a compromise package, with a formula removing the rebate from the costs of enlargement, or the UK paying a "fair" share in other ways. Mr Blair may well be asked to make such a commitment in March.

The Prime Minister, however, faces difficulties across the economic agenda. The Government worked with some success to close down the issue of tax harmonisation which has dogged it over the past few weeks. The summit conclusions suggested there was no desire for "general tax harmonisation", but the advent of the single currency next year can only increase pressure for co-ordination of economic policy, including tax.

The Austrian prime minister, Viktor Klima, summed up by saying that, on approaching the launch of the euro, "economic policy co-ordination" was the "over-reaching aim". Leaders, indeed, agreed a commission for a study on company taxation

Meanwhile, Germany, which will hold the EU presidency from January, called for a speeding up of the battle against "unfair" tax competition. This includes the controversial withholding tax, a plan to deduct 20 per cent tax on the interest from savings. Britain opposes this on the grounds that it would devastate the Eurobond market. But alone, apart from Luxembourg, Britain will face pressure to concede and could pay a heavy political price in Europe for defending city traders.

But the position for Mr Blair is far from hopeless. Politically, he is unchallenged at home and he remains popular in Europe. If he is out of step with the new politics of Europe's left, other governments have yet to produce a coherent and plausible short-term agenda. There is no prospect of harmonising income tax rates, and moves to do so with corporate taxation will take years to achieve. Paris and Bonn are talking not about uniformity but about bands or minimum rates.

Even if states could be persuaded to go along with the idea of harmonised taxation, each operates different corporate tax regimes that would have to be aligned before the tax rates.

On employment targets, the latest Franco-German project, there is little clarity about the specifics. An employment pact could be troublesome for Mr Blair, but Britain would have little difficulty with Europe-wide objectives for placing the unem-ployed in job-creation schemes.

Meanwhile, aware that threats to veto tax measures have only inflamed the situation, Downing Street has been working hard to bolster alliances. Mr Blair's carefully crafted message for the weekend has been a tone of positive engagement in Europe, combined with an attack on the Eurosceptic media. And Labour's spindoctors have resisted gar-nering Eurosceptic headlines.

If Vienna achieved little in concrete terms it did prove that the Government can switch tactics - from threatening the veto to bridge-building. But whether or not the truce survives the next crucial six months, is another question.