What fiscal competition will there be from the CEEC?

The paper examines what strategies the future Member States employ to increase their attractiveness for foreign investment and the competitiveness of their companies.

Except for indirect taxation and State aid, the “acquis communautaire” leaves a wide margin of manoeuvre to the Member States in the field of taxation. What strategies do the applicant countries follow in order to increase the attractiveness of their territory and the competitiveness of their companies?

The strategy of reducing direct taxation…

The pressure of taxation, measured by the level of the tax revenues returned to GDP, is generally lower in the CEEC than in the EU. This is not a surprising situation for catching up economies; however the gap has widened since the beginning of the transition period. Nevertheless, we notice that this ratio varies from 26.8% in Lithuania to 38.6% in Slovenia, that is to say a level higher than that observed in Ireland, Portugal or the United Kingdom. A direct comparison of the structure of tax revenues indicates a clear will to favour a reduction in direct taxation. Although recourse to raising indirect taxation is partly related to the implementation of the acquis * (in particular the harmonisation of excise duty rates), the normal rate of VAT is relatively homogeneous and on average higher in the CEEC than in other EU countries (approximately 20%, as against 19.4% in the EU).

…in order to support companies and attract FDI

Tax reliefs have essentially benefited companies and the rates of corporation tax prove to be significantly lower than those observed in the EU. Hungary and the Baltic States are thus characteristic of small peripheral countries trying to benefit from a competitive advantage, following the example of the Irish strategy. The issue at stake for the CEEC is also how to attract the foreign investments needed to sustain economic development and fund the current account deficit. It is with this in mind that Estonia does not tax ploughed back profits and that free zones or special schemes were set up. Such zones can be of considerable economic weight; they concentrate 40% of exports in Estonia and 35% in Hungary where it is estimated that they account for approximately 100,000 jobs. Within the framework of the accession negotiations, the abolition of some of these measures, which involve a distortion of competition, was compensated for by the installation of limited transitional periods (this is the case of the Special Economic Zones in Poland where corporation tax reliefs will only be maintained for SME until 2010 or 2011).

Incomes from work remain lightly taxed overall, even though social security contributions are high.

The clearest difference in the structure of taxation lies in the low level of income tax revenues in the CEEC. The tax base is narrower, due to the weakness of incomes and the greater incidence of tax evasion, and marginal rates are lower (for the higher income brackets, the marginal rate does not exceed 40%, except in Slovenia). Consequently, income tax is less progressive in the CEEC (Estonia even applies a single rate).

Although income from work is lightly taxed, the share of the working cost attributed to the payment of social contributions is comparable to those practised in the remainder of the EU. The social security system remains indeed relatively generous and its financing must face the dual challenge of a decrease in the employment rate and an ageing population. On the whole, the effective rate of taxation on the work factor, which takes into account income tax and social contributions, remains low (33% in the CEEC as against 41% on average in the EU in 1999, according to WIIW).

In their medium-term strategy, many CEEC have planned to continue cutting corporation taxes, but the resulting loss of revenue will severely limit their margin for manoeuvre within a context of growing fiscal deficit. In these circumstances, one would expect to see a significant rise in the taxati on of the least mobile factors and in particular a rise in income tax rates and a widening of the tax base, accompanied by an improvement in the standard of living.

For more analyses, see the

enlargement website of DREE.