EU leaders to tread carefully in thorny tax debate

BRUSSELS Thu Mar 1, 2012 12:34pm EST

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BRUSSELS (Reuters) - EU leaders will raise the thorny topic of tax policy on Thursday, as Germany and France rekindle a debate that smaller states fear could ultimately force them to surrender low tax rates which have been a magnet for foreign investment.

Diplomats from the 27 European Union states have wrestled for decades over tax policy, which touches on highly sensitive issues: national sovereignty, fears of what some see as creeping European federalism and, not least, money.

In a draft statement to be issued after a summit concluding on Friday, leaders will commit to "review their tax systems with the aim of making them more effective and efficient, removing unjustified exemptions, broadening the tax base, shifting taxes away from labor ... and tackling tax evasion."

Innocuous as that may sound, some fear it masks a move to force through harmonization of taxes across the union.

That would not go down well in smaller states such as Ireland, which has been at odds with the bloc's leaders since it declined to give up its low tax regime in talks on its EU-sponsored debt bailout.

Irish academic Frank Barry said the debate on tax was broadly one of rich against poor.

"Small countries need to have a competitive advantage. We are not going to give it up unless there is something huge to compensate us," said Barry, an expert in Ireland's tax regime at Trinity College Dublin.

"The only compensation would be if the EU were to develop into a fully federal system."

He suggested one alternative would be for a central EU budget to compensate countries suffering economic shocks - such as Ireland's banking crisis - in the same way as the U.S. federal budget helps flagging regions.

But that is precisely the sort of increased fiscal co-responsibility that Germany has resisted throughout a debt crisis that has also seen it back the bailouts of Portugal and Greece.

Germany, home to some major global manufacturers, and France have launched a program to align the way they calculate corporation tax as well the rates they apply, in a move one minister in a neighboring country privately described as a "missile."

Others fear being forced to follow what one Brussels diplomat described as a "Germanic" agenda, set by Europe's biggest economy and most populous country.

Berlin's ambitions go beyond closer tax alignment with France. It also supports a proposal by the European Commission for a common approach in calculating tax by standardizing company tax breaks across the 27-country bloc.

Although the EU executive's proposals are voluntary and leave countries free to set their own tax rates, some see it paving the way for a minimum rate of corporate tax.

"The issue of a common rate in the EU is closely linked to the project of a common system to calculate corporation tax in Europe," said a spokeswoman for the German finance ministry, although she added: "A common rate is not on the agenda for now."

But such reassurances do little to ease concerns in Ireland, which is home to more than 1,000 multinational companies, employing roughly half of the country's manufacturing and services workforce.

Malta, the Netherlands and others share these worries and attacking Dublin's advantageous 12.5 percent rate would be playing with fire ahead of a domestic referendum on a new fiscal pact to tighten economic management in the euro zone.

"Ever since the 1950s, Ireland has built its economy on low corporation tax," said John Fitzgerald, of the Economic and Social Research Institute, a Dublin-based think-tank.

"To get rid of it now would push the economy into a nosedive that it might not get out of," said Fitzgerald, who also sits on the Irish central bank's board. "Germany believes every country's economy should look like Germany's, but not every country can."

(Additional reporting by Stephen Brown in Berlin and Padraic Halpin in Dublin; Editing by Hugh Lawson)

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