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Global Tax Review - Tackling the Debt Crisis

By Editorial
April 7, 2012

As is to be expected, with the Eurozone crisis far from resolved, Greece teetering on the brink of bankruptcy, and the US once again facing a federal deficit in excess of a trillion dollars, fiscal developments in the European Union and the US have tended to dominate the tax headlines in recent weeks.

European leaders hope that their new 'fiscal compact', an outline of which was agreed by 25 of the 27 member states at the last meeting of the European Council on January 31, will be able to contain future crises by subjecting national budgets to an effective 'peer review' by the EU which will seek to ensure that tough new deficit limits are adhered to. It is due to be signed at the next meeting of the European Council in March.

According to President of the European Council Herman Van Rompuy, this new treaty "is all about more responsibility and better [budget] surveillance".

"Every country that signs it commits to bringing a 'debt brake' or 'golden rule' into its own legislation, and will do so at constitutional or equivalent level," he explained. "New voting rules and an automatic correction mechanism will enforce compliance more effectively."

An agreement between the 17 eurozone member states on the treaty for the European Stability Mechanism was also endorsed. Described by Van Rompuy as a "permanent firewall [that] will prevent contagion in the euro area and further restore confidence", finance ministers are expected to sign it at the next Eurogroup meeting to ensure that it takes effect from July 2012.

The UK, unsurprisingly, was one of the two member states which did not vote for the new 'fiscal compact' treaty, although it is unclear whether Prime Minister David Cameron has decided to veto the new measures, or is opting the UK out of the proposed treaty. In any event, Britain's traditional euroscepticism is not likely to derail the EU train which seems inexorably headed towards some form of budget harmonisation, if not fully-fledged tax harmonisation.

The other dissenting member state, the Czech Republic, plans to hold a referendum on whether or not to join the proposed fiscal compact. Prime Minister Petr Necas has indicated that a referendum on signing up to the pact could be linked to a second referendum on adopting the euro, while underscoring that the government's final decision would depend ultimately on the eventual text of the treaty. However, Czech President Vaclav Klaus is vehemently opposed to the country's participation in plans for the treaty, and warned recently that he would not sign it.

The Czech Republic is deeply divided on the issue of greater tax harmonization and further European integration. While Prime Minister Necas's centre-right Civic Democrats currently oppose such plans, the conservative TOP09 party backs EU integration, rejecting plans for a referendum.

While the EU is expected to forge ahead with the fiscal compact regardless of British and Czech objections, the UK's non-participation in the proposed European financial transactions tax (FTT) is giving the main proponents of the tax something more of a headache.

Under European Commission proposals unveiled last September, a 0.1% tax on shares and bond transactions and a 0.01% levy on derivative transactions would be applied from 2014, to yield an estimated EUR55bn (USD70.1bn). However, with the overwhelming majority of European financial trading taking place in London, the UK is understandably not keen to become the new cash cow for the EU budget, and the Conservative majority in the coalition government has issued dire warnings as to the consequences of such a tax, not only for the UK but also the European economy.

Delivering a speech at the recent World Economic Forum in Davos, Prime Minister Cameron said that: "Even to be considering this at a time when we are struggling to get our economies growing is quite simply madness".

He said that it was "right" that the financial sector should pay their fair share, and noted that the UK has several measures in place to do so. These include bank levies and a stamp duty on shares. Cameron pointed out: "These are options which other countries can adopt".

However, Cameron also highlighted the European Commission's own original analysis with regard to the FTT, which, he claimed, shows that the imposition of an FTT could hit the EU's GDP by EUR200bn (USD265bn). In addition, 500,000 jobs could be lost, and 90% of financial markets could be forced away from the EU, he said.

The French response to this debate has been to forge ahead with its own FTT, in the hope that it will encourage other EU member states, and indeed non-EU countries, to follow suit. Ahead of the upcoming presidential elections in France in April, French President Sarkozy announced plans on January 29 to introduce a tax on financial transactions in France in August. A 0.1% tax will be imposed on all transactions in French securities, with credit default swaps and speculative 'automated' trading also subject to the tax. Expected to yield around EUR1bn (USD1.3bn) annually to help reduce the budget deficit, the provision is intended "to create a shockwave and to set an example", the President explained.

While the French and Germans normally march in lockstep on European tax issues, it is becoming clear that the two governments are moving at different speeds now with regard to the FTT, as Chancellor Merkel seeks to smooth over differences on the issue within her often fractious 'black-yellow' coalition government.

Underlining the need for the financial sector to contribute to the cost of the crisis, and determined to gain support for any such plans from the British government, German Economy Minister and leader of the ruling Free Democratic Party Philipp Rösler favours the introduction of an EU stock market sales tax, based on UK stamp duty, as an alternative to the controversial financial transactions tax, currently dividing opinion within the coalition, and indeed within Europe. In the UK, a Stamp Duty Reserve Tax (SDRT) is currently imposed on paperless (electronic) share transactions at a flat rate of 0.5%. In 2006, the UK government generated income from the tax of around GBP3.8bn.

Defending his proposal, the FDP leader stressed that if the UK is not prepared to consider the idea of a European financial transactions tax, then it makes sense to discuss an alternative. It is in Germany's interests to have the UK on board with any plans, Rösler insisted, warning that a financial transactions tax introduced at eurozone level would merely lead to competitive disadvantages for Frankfurt, and result in an increased burden on customers.

The United States government, which has rejected the idea of a financial transactions tax imposed at the G20 level, would only be too happy to stand by and watch business flow from London and Frankfurt to New York should the likes of Sarkozy and Merkel realize their desire for an EU-wide levy. However, like the Europeans, the US Administration and Congress are also battling a serious debt problem, and the Congressional Budget Office's 'baseline' annual budget projections, assuming that current fiscal laws remain unchanged, project a USD1.1 trillion federal budget deficit for fiscal year 2012.

Measured as a percentage of US gross domestic product (GDP), that 7% shortfall would be nearly 2% below the deficit recorded in 2011, but still higher than any deficit between 1947 and 2008.

Over the next few years, the CBO's baseline deficit projections would decline markedly, dropping to under USD200bn and averaging 1.5% of GDP over the period from 2013 to 2022, assuming temporary tax cuts are allowed to expire. However, with substantial changes to tax and spending policies projected to take effect within the next year, the CBO has also prepared forecasts under an "alternative fiscal scenario," in which some current or recent policies are assumed to continue in effect, even though, by law, they are scheduled to change. For example, if expiring tax provisions (other than the payroll tax reduction) are extended, the alternative minimum tax is indexed for inflation after 2011, Medicare's payment rates for physicians' services are held constant at their current level and the automatic spending reductions required by the Budget Control Act do not take effect, far larger deficits and much greater debt would result than are shown in the CBO's baseline. Indeed, deficits would average 5.4% of GDP over the 2013-2022 period, rather than the 1.5% reflected in the CBO's baseline projections. Public debt would then climb to 94% of GDP in 2022, the highest figure since just after World War II.

Long-term solutions to a bloated government budget and a tangled and inefficient tax code are, however, unlikely to be approved by a divided Congress split sharply along ideological lines, especially with the added complication of presidential elections in November this year.

While the European and American debt crises are posing major challenges for their governments, spare a sympathetic thought for Japan's Prime Minister Yoshihiko Noda, who must wish his problems were that simple. Japanese sovereign debt has risen to well over 200% of gross domestic product, but Noda still has to find money to shore up the social security system which is coming under increasing strain from Japan's ageing population while at the same time keeping voters happy, not to mention the members of his own party. And the government has promised to halve the country's fiscal deficit over the period from 2010 to 2015, while achieving a primary surplus (net of interest payments on its debt) by 2020.

Noda has grasped the fiscal nettle by insisting that consumption tax must rise in order to maintain the solvency of the social security system - traditionally a very unpopular policy in Japan. But his proposed phased 5% increase in the tax to 10% by October 2015 in all probability will not nearly be enough for the government to achieve its budgetary targets. Even after the increase, and using conservative growth assumptions, the Cabinet Office has estimated that the deficit would, by 2020, still remain over 3% of gross domestic product. In its turn, ratings agency Standard and Poor's has confirmed that such a doubling of consumption tax would not have a dramatic enough effect on Japan's fiscal deficit, nor go far enough in slowing the growth of its public debt, to provide for a change in the country's rating outlook. The agency says that only a (politically impossible) increase in consumption tax to 15% would securely avoid possible further ratings downgrades.

It still remains doubtful, however, that even the already-planned consumption tax rises will happen. The political opposition has rejected Prime Minister Yoshihiko Noda's call for bipartisan talks on the tax increases, and has repeated its demand for an early general election before considering the increase.

Despite the severity of the sovereign debt crisis in various parts of the world, solutions to tackle it do not look like emerging overnight. If recent history is anything to go by, Japanese Prime Ministers are rarely in the job long enough to see through their tax reform plans, while getting the 27 EU member states to agree on any issue is never straight-forward, and usually ends up with many compromises having to be made. And given the highly partisan nature of US politics at the moment, Congress is likely to go on patching and mending the tax laws and tinkering around the edges of the debt crisis unless there is a decisive result one way or another on November 6, when, in addition to the presidential race, all 435 seats in the House of Representatives and 33 seats in the Senate will be up for grabs.


Tags: France | European Union (EU) | unemployment | tax | United States



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