Euro tax traps Brown

WITH its air of modern efficiency the Swissotel in Brussels was hardly the place to expect an ambush. But when Gordon Brown, the Chancellor, sat down with socialist finance ministers last Sunday for a dinner of quail mousse with pine nuts followed by guinea fowl with chicory, something less palatable was on the political menu.

The issue which was to detonate - tax harmonisation in the EU - could hardly have been more sensitive and, after seven feverish days, the Eurosceptic press remains in ferment.

The evening began well enough with Mr Brown placed between Neil Kinnock, the European commissioner, and Oskar Lafontaine, Bonn's left-of-centre finance minister. But when the issue of tax harmonisation was raised the atmosphere changed, the discussion becoming more forthright. According to one witness a game of "verbal ping pong" ensued between Mr Brown and Mr Lafontaine. Within hours the two men were at the centre of a public row, Mr Brown threatening to veto any such moves.

The spark for this conflagration came from an unlikely source, a Belgian socialist politician called Phillipe Busquin, who holds the post of chair of a working party on taxation for the Party of European Socialists. That group has control of 11 of the 15 EU governments.

Before the Swissotel dinner the paper had been distributed to socialist finance ministries. It was a document for debate, not one designed to bind parties. But for the Government, struggling to bring British public opinion around to the idea of closer involvement in Europe, the ideas were dynamite. The document, calling for "minimum corporate tax rates within the EU", argued: "Direct tax co-ordination has to be on the agenda in order to avoid harmful tax competition." It went on: "Diversity and competition among countries in the single market are only desirable if a framework of common rules for tax competition is established."

With little hope of keeping the proposal quiet, Mr Brown went public with a pledge to veto any further moves to harmonise tax. Predictably, Mr Lafontaine was not backing down either. He told journalists that a move to harmonise corporate taxes, and to end "tax dumping", could be a priority of the German presidency of the EU, which begins in January.

The Lafontaine line appeared to be endorsed by France's finance minister, Dominique Strauss-Kahn, and by the Italian premier, Massimo D'Alema. By the end of the week the European Commissioner for economic and financial affairs, Yves-Thibault de Silguy, had suggested that income tax rates might, one day, be harmonised. All of which left a muddled picture little short of a gift to Eurosceptics.

In fact Mr Brown faces two problems, the first of which is a difficulty posed by the EC's proposals for tax harmonisation. The man at the centre of these is Mario Monti, an Italian former professor of economics, now European Comm- issioner for the internal market. He approaches the issue from a different perspective to that of Mr Lafontaine and Europe's new left. He is a conservative who is alarmed when his agenda is interpreted as a covert way of raising tax. "There is no question of increasing the overall tax burden in Europe," he said on Friday. "It would be preferable to reduce gradually the tax burden so as to boost the EU's competitiveness." But he wants the single market to be accompanied by measures which reduce "harmful" tax competition. To combat this, the commission has won agreement to a voluntary code of conduct.

More problematic for Britain is a proposal for a withholding tax on savings, designed to combat the problem of cross-border competition. German investors, for example, can avoid paying tax on interest in their bank accounts by crossing into Luxembourg and opening a non-resident account.

The difficulty is that Mr Monti's measures would hit London's lucrative eurobond market if it requires a 20 per cent deduction on interest payments. That, the City argues, would drive the eurobond trade out of London, threatening 11,000 jobs. Britain, which can veto the plan, is calling for an exemption for eurobonds.

Logically such a move would, Mr Monti responds, distort the market in favour of one sector. The commission is offering a lengthy transition period to phase the move in and argues that Britain could benefit from other moves to deregulate financial services in the EU. Mr Monti hopes to apply political pressure on Mr Brown next year. But negotiations remain deadlocked and the stage is set for a battle concluding next summer - either with a compromise or a British veto.

Then there is a political difficulty. At a press conference in Brussels on Wednesday Mr Monti backed away from early moves, but set out a broader vision for tax harmonisation. It laid down three categories: income taxes, which would never be harmonised; VAT, energy taxes and excise duties, where more harmonisation is desirable; and business taxes where the commission would be willing to act. "I am not," Mr Monti said, "proposing a minimum rate of corporation tax."

The strategy is shrewd. Harmonising corporation tax across Europe would not only be politically explosive, it would be complex since the 15 countries have different tax bases. Mr Monti wants to achieve his limited package of measures next year, hoping the advent of the euro will create more pressure for harmonisation of corporate taxes in the longer term.

Others are less patient. The speed with which last week's debate accelerated out of control bodes ill for Mr Brown. Behind the scenes, officials at the socialist group are planning a new document designed to pick up where Mr Busquin left off. They want to reach a common position on tax harmonisation for all the socialist parties before next year's Euro elections.

To that end the next meeting, to be attended by aides, is scheduled for January. Each way he looks, the dilemma is familiar and acute for a Chancellor anxious to maintain influence in Europe despite Britain's non-participation in the euro. Either he compromises and provokes a backlash at home, or he stands firm and risks marginalising himself in Brussels. But governing, as Mr Brown is very fond of saying, is all about tough choices.