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Outline of the report and executive summary
These five sets of conditions for a successful contribution by the proposed Directive to what one might call 'European Union progress' are addressed successively within the limits of this report in five parts with reference notably to the perspective of the European citizen. The objective, again, is not to be exhaustive nor is it to repeat technical analyses that more qualified organisations can present from their specific professional standpoint. Quite modestly, the purpose of the report is to present a coherent analytical framework in which to debate the conditions under which the proposed Directive - in its present state or after some improvements and changes - could succeed. Success is understood in the broad sense of achieving this complex blend of market objectives and social objectives which give true meaning to the Union for European citizens.
Part 1 begins by looking at the objective of creating a 'level playing field' for taxation of interests payments in the broader context of European integration. After a brief history of the developments that led to the proposed Directive, particular attention is devoted to the objectives of social justice and fairness that give it its political legitimacy. The report discusses notably the various perspectives in which 'fairness' might be defined, not all of which necessarily coincide with the choice made by the German Constitutional Court in Karlsruhe and extended to the Union as a whole in the proposed Directive. In light of liabilities, it challenges the notion that fairness necessarily coincides with taxing savings at the same rate as salaries and wages, ending with calls for a more sophisticated debate that could open the way to a European perspective on taxes.
The level at which the withholding tax should be set is obviously a key aspect in the 'levelling' of this playing field. The report looks at the rationale behind the Commission's proposal for a 20% withholding tax and at the role played by a 'corrective mechanism' whereby individuals could choose to be exempt so as to be taxed in their country of residence. On this, the report finds that the Commission's efforts to assess the appropriate tax level omits one major source of distortions for the 'level playing field', namely the massive tax exemptions and tax incentives that most Member States have put in place to keep savings in State approved instruments such as 'Livrets A' in France. It also questions the timidity of the Commission in looking at citizens as irrevocably belonging in only one national tax system, at the very moment when they are about to share one single currency and when they already share one supranational Court of Justice, the Schengen freedoms to cross borders without police checks and even the right to vote in local elections of Member States different from their own. Altogether, the proposed Directive appears to identify obstacles to a level playing field in a manner biased toward keeping investors at home.
Part 2 looks at key features that will be central to the success or failure of the proposed Directive, namely the 'coexistence mechanism', the 'corrective mechanism' and the fact that the withholding tax is not intended to be final.
Two options would seem to be easier to implement while also bearing a clearer relationship to the overall European integration agenda:
- The first option would be to make the withholding tax final, thereby acknowledging that citizens of one Member State are also treated as citizens of the Union, able and willing to pay taxes in several countries just like they can vote in local elections in several Member States.
- The second, more traditional, option would be to wait before introducing the withholding tax until Member States have put in place the level of harmonisation between national taxes on interest payments that would make a common EU 'superstructure' much easier to administer. Most probably, this second approach is likely to be more time-consuming. Also, unlike the first approach, it would imply more interference into national tax structures and less subsidiarity.
Hence the strong recommendation in this part of the report to 'cut the Gordian knot' by making the withholding tax final: rather than a complex (and maybe unworkable) bridge between national tax systems, it would become on the side of VAT and excise tax the second element of a truly European tax policy that would continue to evolve gradually in a consensual rather than divisive manner.
Part 3 turns to the element of tax evasion and to the likelihood that the proposed Directive will make possible major progress on this front. The report finds that the proposed Directive will leave open major loopholes, both within the Union itself and in the context of the competition with off-shore centres.
Regarding the intra-Union 'lawful loopholes' the report discusses the implications of the proposed Directive of taxing interest payments separately from other types of financial gains. This may sound simple in a Brussels office, yet swap markets and financial innovation are seen as likely to contribute greatly to the proliferation of 'lawful loopholes' that this fragmented approach entails. This is likely to trigger an abundant stream of technical adjustments and counter-measures by EU tax authorities that could be detrimental to the predictability of the EU tax framework. This risks also to create a permanent climate of suspicion, thereby leading a number of citizens or Member States to question the democratic legitimacy of EU actions in these fields.
As for the 'off-shore loopholes', the report expresses strong doubts as to the practical significance of the hopes put by the proposed Directive in those Member States with 'special responsibilities' over some of these off-shore centres. It also discusses the likelihood - or non likelihood - that Switzerland, home to more than a third of the world's private banking activity, will co-operate in such efforts. The report draws special attention to the new dimension in cross-border investment to be expected from the new stages of Internet-supported financial services and to the massive technology investments undertaken by some off-shore centres, notably Switzerland, for the purpose of private banking. The encryption and communication technology presently being deployed will provide investors with highly securitized, on-line access to 'companion accounts' open with the Bermuda or Bahamas subsidiaries of banks within or outside the Union's reach, notably by Swiss banks. Baring much more precise negotiations with other OECD countries - first among which Switzerland -such 'double-bottomed' accounts have the potential to defeat any harmonisation that might emerge, not just from the proposed Directive but also from what are expected to be strong EU and German pressures on Switzerland regarding Swiss participation in a withholding tax mechanism.
Altogether, the report challenges the notion that the Directive will produce much in the way of fighting tax evasion and, probably, of generating additional revenue. The risk is then that small investors will feel discriminated against and that the complex procedures contemplated in the proposal will be hard to relate to clear benefits.
Hence the recommendation is to approach tax evasion in a broader context of trust between governments and citizens. Trust is not mandated but can only reflect a two-way process of transparency and accountability in which citizens are addressed not as a 'gang of potential cheaters' but as the ultimate source of purpose and of legitimacy for collective action. Rather than embarking on the low road of mediated denunciations of tax evaders and of 'loophole policing', EU governments have everything to gain by following the high road of shared ethics, of mutual accountability and of shared purpose. After all, taxes are not what is 'owed' to officials and public servants, taxes are what we pay for civilisation.
This implies however that governments continue the progress they have made over the last decades toward financial responsibility and transparency. It also implies that they refrain from introducing new sources of distortion in the field of corporate tax or of capital gains, for instance by putting national debt instruments or giving tax advantages to locally listed securities.
Part 4 looks at the contribution, either positive or negative, that the proposed Directive can make to the global role of the euro, in line with the fourth recommendation in the ECOFIN mandate of 1 December 1997 concerning the need to preserve 'the competitiveness of European financial markets on a global scale'.
The lack of consultation between the Commission and the major professional associations has contributed to the bitterness of the present debate. This represents a striking and ill-advised departure from the usual EU practice. The inward-looking spirit in which the proposed Directive has been drafted can probably be understood in light of the long and difficult road toward EMU that Member States have made the effort to follow. Yet, this Europe-centric perspective has major shortcomings on the eve of the 'two currency world' in which the Union will have to adopt a global perspective. The report concludes that the proposed Directive still reflects a 'European euro' perspective, in some cases maybe a 'parochial-euro' perspective. This at a time when the euro is about to become one of the world's two anchor currencies rather than simply the cornerstone of intra-European integration.
This inward lookingness can be explained in part by the fact that the euro will make the Union less open in terms of trade to GDP ratios if the euro zone is considered as one 'country'. Yet, this will not apply to monetary relations where, on the contrary, massive portfolio diversification should be expected to the tune of 400 USD to 1,000 billion USD over a few years, with the usual pendulum effects.
The report warns therefore against the feeling that the Union needs to pay less attention to the rest of the world after the euro because it is most probably that the opposite will happen in a world no longer defined by trade ratios.
Part 5 calls attention to one essential element in the 'transmission belt' between European and global finance, namely the Eurobond markets - more generally, the fixed income euromarkets. The impact that the proposed Directive can have on the working and localisation of these markets is discussed in the light of their strategic significance for the Union.
Calls for blanket exemptions of the euromarkets notwithstanding, a major difficulty in crafting a more nuanced approach to tax harmonisation is the blurring of the lines that used to separate such markets from the domestic European capital markets. The creation of the euro is indeed disposing of the very notion of 'domestic bond markets'. The report therefore presents the strong reasons behind the refusal by the Commission to exclude euromarkets from the proposed Directive. It then looks at the criteria that had been put forward by the Commission, after in-depth consultation and co-operation with IPMA, in the Prospectus Directive to exclude euro issues. The report finds that these pragmatic criteria based on the cross-border nature of syndication and issuing will no longer be appropriate for markets in euro as the latter will be, by nature, cross-border.
The report then presents the 'consensus' scenario put forward by IPMA, ISMA and a number of other prominent professional associations in August and September 1998 to alert policy makers to the risks of delocalisation of euromarket activities that these associations see as the logical consequence of the proposed Directive in its present drafting. The job losses are expected to be in the order of 11,000 in London and 1,400 in the custody and paying agent activities in Luxembourg and London. But what will be lost is more than highly skilled, well-paid jobs. It is also the position of the Union as the premier gateway into the one-trillion-dollar-markets in USD and in major currencies from the whole world. The irony is that euromarkets will be where many European companies - and quite a few governments - will go to raise capital in euro: does anyone really intend to have them travel to New York or Zurich to find euros under the best terms and conditions?
Defining 'euromarkets' is therefore an essential aspect in any effort to deal with the implications of tax harmonisation for the euromarkets. This should probably be done more in terms of 'wholesale' vs. 'retail' than of 'on-shore' or 'domestic' vs. 'off-shore'. The euromarket community is invited by the report to take the initiative of preparing new guidelines that would allow to tell 'wholesale' from 'retail'. In light of the fact that the two can be highly intertwined - especially when 'high net worth' individual investors are involved - it could be that euromarket firms would gain by separating their own placement process in ways giving greater clarity to this wholesale/retail divide. In any case, such an effort has clearly not been made and no time should be lost, either by the Commission or by market practitioners, in coming up with a typology that citizens can understand and on which regulators can build.
Reaffirming the central objective of further progress toward European integration, the report concludes by putting forward a number of suggestions regarding the final form that the Directive could take.
A first, central recommendation is to take the time necessary for the dialogue and the preparatory work needed for the proposed Directive to avoid at least the major pitfalls that are bound, in its present state, to make it a quite ineffective source of additional income and, yet, also a major headache for European banks and financial institutions. Moving from a confrontational to a 'win-win' perspective is essential at the very moment when the Union has to make the euro a success on the global markets.
Achieving a 'level playing field', dare we suggest, should not take the form of setting up an excessively complex set of procedures that will slow down rather than speed up all the players in that field while also pushing some of them to leave the Union altogether. Beyond the fight against 'harmful competition', the real challenge, in a 'Monnet perspective', is that the Commission is now called upon to open the field of tax policy for this 'ever closer union' which is the true purpose of all these efforts.
Now is the time for the Commission to administer one critical ingredient for success in the form of yet another illustration of its capacity to think boldly and to catalyse the Council into enlightened, far reaching initiatives. Ours is not a world in which status quo policies provide firm foundations for social progress. The Commission should therefore be encouraged to take the time to consult, to call attention to the emerging post-euro agenda in a positive rather than defensive manner and to have the audacity of breaking half-hearted compromises. Making the withholding tax final would at the same time eliminate many circumvoluted procedures and contribute to citizens looking at the Union as their home beyond the national home. Sometimes, the 'Monnet method' is also about cutting Gordian knots rather than about attaching new strings to help live with it.
