EU hunts for a tax system to save jobs

European Union governments will today be asked to take the first highly controversial steps towards the harmonisation of direct taxation.

Finance ministers meeting in Luxembourg will be urged to sign up to plans to collaborate on company taxation to avert a damaging slide towards tax "competition" between member states after the launch of a single European currency in 1999.

More than a third of EU unemployment, running at 18 million, is directly traceable, EU officials now believe, to the shift in the burden of taxation away from capital onto labour. That shift has been provoked by aggressive competition between member states to seduce multinational investors with corporate tax perks and incentives.

The growing consensus in Brussels is that divergent tax systems and rates among the member states will destroy even more jobs after the launch of the single currency.

No longer subject to exchange risks and transaction costs within the EU, capital will become even more mobile, so tax will become the big deciding factor for companies selecting investment locations. But the most worrying trend is for governments to compensate for lost revenue on company taxation by heaping costs on labour, with obvious consequences for jobs.

According to the Commission, as much as 4 per cent of EU unemployment can be blamed on the shift in the burden of taxation from capital to employment over the past 15 years. Taxation on wage-earning labour has risen from 35 per cent to more than 42 per cent but, for capital, has fallen from 45 per cent to below 35 per cent on average over this period.

There is growing alarm at the extent to which bosses of multinationals can avoid income tax by exploiting different tax residency laws in the EU, while low-skilled workers in small companies, whom Brussels calls the "fiscally immobile", bear the brunt of direct taxation. For this reason the Commission's plan will introduce the notion of a European fiscal "citizenship" to suppress differences between tax residency and non residency.

Mario Monti, the EU Commissioner for taxation policy who drafted the co-ordination plan, warned yesterday of a "potential explosion of political conflicts between the member states" unless action is taken.

Britain, which strenuously opposes ceding the national veto over taxation and any moves to harmonise tax within the EU, will greet the proposals with extreme apprehension.

Reflecting the political sensitivity that surrounds direct taxation, Mr Monti's proposals at this stage are for a tax "code of conduct" whereby member states would agree to a moratorium on company tax perks used by some governments to poach jobs and multinational investment from their neighbours.

The code would be non-binding but would be given teeth by a system of "peer review" whereby other governments could judge if a country's tax rates were harmful to the EU as a whole. The move will arouse suspicion that Brussels is unveiling the thin end of a wedge leading progressively to a single tax authority and, ultimately, the harmonisation of national taxation.

Mr Monti, whose proposals are the culmination of months of study with national tax advisers, said his initial priority was to achieve a standstill on corporation tax perks but admitted there were growing demands for a minimum rate or a common "floor" on corporation tax.

He said it would not be realistic to expect immediate agreement on a minimum company tax rate common to all member states. To be consistent, this would imply full harmonisation of the tax base, but, noting that even co-ordination would have been unthinkable some years ago, he said: "Perhaps one day that will be the outcome." He predicted that the integration of markets and institutions which would follow the single currency would make it easier to aim for "a much higher degree of tax homogeneity within the EU".

In the meantime, he said, the first step would be to abolish or phase out special tax regimes used, for example, by Ireland to secure 14 per cent of all new investment in the EU last year. The Netherlands and Belgium have also come under fire from Bonn for offering special tax deals to tempt big German companies across the border.

Luxembourg, which holds the EU presidency, is also a target by virtue of its refusal to levy a withholding tax on savings, a ploy to attract foreign investors. Germany estimates that it is losing about pounds 7bn a year in potential revenue to Luxembourg.

Luxembourg's Premier, Jean Claude Juncker, who is also the country's finance minister, is now prepared to discuss a withholding tax provided colleagues agree to a wider package of tax co-ordinating measures.

A spokesman for the Treasury said Britain's overriding concern at today's talks would be to ensure that direct taxation remains a matter for national sovereignty.

"Clearly it is right that harmful tax competition should be addressed but any code must be voluntary and non-binding," the spokesman said.