On board a plane once I found an interesting article in the Financial Times. Even though I have not saved it physically, which is a pity, I remember its contents perfectly well. It was a short article about a pressure by international institutions on low-tax-rate countries (offshore countries) to raise taxes and to stop the game of harmful competition. The article quoted the response of the head of government of Jersey - one of the offshore countries – essentially implying: why should we raise taxes if with low tax rates we are able to collect the funds sufficient for funding the government. I was amazed at the straightforwardness and simplicity of the reply. You have to agree that one can hardy imagine the head of our or a neighbouring state uttering such firm and indisputable words.

 

We are mainly used to quite a different type of rhetoric followed by particular steps in the area of tax reform. “In line with the European Union directive requirements”. “This contradicts the practice in the EU”. “This is the way most European Union Member States do”. For several recent years such taxation arguments have become familiar to our ears. No one even really attempts to dispute the argument of integration into the European Union. Trying to adapt and not to stand out, this is true even in those areas where no formal requirements exist. I do understand why. This is convenient and safe for those who suggest and those who implement tax reforms since they claim: it’s not my idea, so responsibility is not mine either. As I see it, Lithuanian politicians would certainly agree on harmonising all the taxes, there would be less trouble and thinking for them. 

 

Fortunately not all European Union Member States are of this view, therefore direct taxes are still an issue of competition. It is common knowledge that attempts to harmonise all the taxes have failed, and so far a compromise solution - the Code of Conduct binding in the field of direct taxation seems to be considered as a satisfactory level of regulation. Nevertheless this does not mean that alignment is not an item of discussion agendas. There were, are and will be attempts to have uniform taxes in the European Union, or at least drive towards such uniformity. The rhetoric used referring to tax competition is more or less as follows (my quotation is taken from an information publication, a booklet on EU taxation system that is a perfect reflection of prevailing views): Tax competition. Decisions about investment, business activities, jobs and earnings are sensitive to differences in national tax regimes and social welfare systems. With increasing mobility and differentials in tax bases, business can identify the components on which they are taxed (taxable bases) and shop around to find the country where tax is lowest. Such competition between Member States puts downward pressure on the level of tax and contributions which may be damaging if it is not regulated, as it undermines the fairness and overall efficiency of tax system. You see. I will come back to these statements in my presentation later.

 

The conference has extensively debated in search for answers to questions: do we want to have tax competition, can harmonisation contribute in any way, in other words, which is better – having the same or different tax systems.

 

I would first of all like to say a few words about a political aspect of tax competition in order to exhaust this matter and to get to exceptionally economic issues. So, a political aspect of tax competition is especially closely linked with democracy, as tax competition is first and foremost the result of democracy in a free world. People elect a government that sets certain taxes. It is due to democracy functioning in the predominant majority of world countries that people have “what they elect”. Tax competition and democracy are two interacting factors. For democracy to continue to be a reality, people need to have a real and not a nominal possibility of choice. In case with the help of universal harmonisation of taxes lower level governments were deprived of an opportunity to exercise their influence in such a significant area – there is no doubt about it – as taxes, the public’s incentives to “participate in democracy” would be considerably diminished. Democracy itself would be diminished. As much as I know, the flag of democracy is still flying in all the countries that have raised it, which suggests that a fully-fledged democracy needs to be characterised by the authority of the elected power to change things, as well as the understanding that people get that their ballots matter. Otherwise, why go and vote for a government that does not decide about key matters, and how to choose from all equally same things?

 

I would like to generalise now by saying that tax competition is the result of democracy and its safeguard in the world. Because it is evident that if one (higher, more distant) government encroaches on the power of the other (lower, local), people will loose interest in the limited lower government, which will lead to undermining democracy. The latter sentence does not imply that I am against limiting government as a mechanism of coercion. A self-willed government is effectively limited by competition, in order to be fully-fledged it must have a multifaceted extensive possibility of decision-making.

 

The modern world experiences tax competition, which is a result of a political as well as economic choice. An opportunity granted by politics to tax competition has given an individual, beside other freedoms, the freedom of economic choice, while tax competition has clarified human choices, their preferences. What are the preferences in terms of taxes?

 

Well, there is no simple and agreed answer as to what animal a tax is. Is it a paid service of a state, or just a tool of redistribution? Taxes combine both in all the countries, for that reason when dealing with human choices, both cases should be considered.

 

In the instances where taxes are payments for services provided by a state, acquisition of a certain function performed by the state, or an unusual way of buying from a particular supplier in a market, each rationally thinking individual is keen on getting a service of the highest possible quality at the lowest possible price. A rational individual acts according to this pattern, according to my observation, unless one is a character of jokes about “nauveaurish”. That means to say that, with other circumstances being the same, an individual always makes a choice out of the same quality services based on price. An individual always wishes to buy the cheapest desired service, and the fact that the service is provided by the state does in no way affect an essential criterion for choice. A person is ready to pay a higher price only in case he/she is buying a service of a higher quality or has no choice at all. My conclusion comes as a question to the audience: is there a better way than competition to promote higher quality services and lower prices? Competition and competition alone has the power of realistic consumer protection. It is for this particular reason that the European Union is so actively safeguarding competition between individual entities. Let's draw a parallel with services provided by the state then: modern tax harmonisation that resembles cartel arrangements should also be prohibited. And as totally different rules are applied to taxes, consistency for the sake of declared values seems to be lacking.

 

In another approach to taxation, an individual is considered as a source paying money and never getting anything from a state in return. In other words, taxes are an instrument of redistribution. In that case an individual's need to wish taxes as low as possible is evident. Great as a sense of solidarity might be, sympathy for the weak can never eliminate an individual’s wish to sympathise and contribute in a personal and personified manner, in addition, he/she has to wish to do so in certain amounts and reduce a compulsory contribution. What a situation might help him/her pay too high a price for solidarity? The question brings me back to competition.

 

Thus, the presence of one's need to pay low taxes does not call for proof supported by special studies or experiments. Life itself as well as human choices made in their everyday lives confirm one's need for low taxes. The proof lies in the popularity of offshore countries, the size of capital flows going there, and the depth and width of shadow economy, therefore the conclusion is that a human being is just human, and his/her wish to live better is still there, it has not disappeared.

 

At this point I would like to return to my quotation about the harm of tax competition in the European Union, which argues that competition between Member States exerts pressure on the level of taxation. The European Union realises that tax competition is a precondition of tax reduction. A conclusion suggests itself that tax harmonisation is aimed at protection from such a pressure. A glance at EU directives brings about immediate realisation that they set a minimum tax rate. What they really do is watchfully protect governments from too low a level of taxation. This motif underpins the endeavour of harmonising taxes in Europe. Crows will not pick crows' (government's) eyes, as a proverb goes.

 

Is there another way of ensuring lower taxes? Can tax harmonisation perform the said function? Referring to harmonisation, I do not refer to the one undertaken by the European Union by setting floor tax rules, I refer to the one when ceiling tax rules are developed, while a government's greed cannot overstep the set ceiling. First, such a solution cannot be expected in several coming decades, second, it would limit the possibilities of those who wish to see higher taxes and better government services, and third, where is the margin of the ceiling that must not be exceeded? What if the margin is set at a relatively high level and if everybody hangs onto it claiming that it is justifiable. Lithuanian municipalities serve as good examples of the latter. They enjoy the right to establish some taxes for their budget tax revenues within certain maximum limits drawn. The result is easy to guess - the municipalities do not doubt about imposing the highest tax rates.

 

One would not dare contest the truth that the lower the taxes the lower the need to have them different. Tax competition is not beneficial in itself. It is a possibility of having low taxes that is beneficial. Should such an opportunity be offered by equal tax rates, need for different tax rates would be phased out.

 

The presence of different taxes is encouraged by a strong economic-cultural, historic and geographic factor, thus numerous reasons, numerous externalities or developments have decided that income taxes prevail in some countries' budget revenues, consumption taxes are predominant in others, while some rely on natural resource taxes. For different reasons some countries have chosen one or another scheme of taxation, which has taken root in that particular state. Nonetheless, what suits and functions in one country may be a failure in another if an attempt is made to copy and implement the latter's scheme there.

 

This rule is also applicable to a tax structure, i.e. what taxes are imposed, and what their rates are. Since countries differ in income levels, a tax burden on different country taxpayers' shoulders is different. We, Lithuanian population, have experienced that disproportion ourselves when excise taxes have been and are still being raised to the European level in recent years. In view of fundamental differences in income, Lithuanian people overpay for financing the needs covered by revenues from excise taxes. And as the imposition of excise taxes rests on the need to finance mitigation of negative externalities, the disproportion in taxation may lead to numerous negative consequences. Tax evasion grows, and labour gets more encouragement to migrate where it can have better possibilities of earning and "carrying the tax burden". A vicious circle of interdependent chains and developments is activated: the budget collects too little and inefficiently, possibility to finance externalities reduces, attractiveness of a state to both labour and capital reduces, possibility to implement the state budget diminishes. Generally speaking, the countries that undertake to carry an unacceptable tax burden are destined to take a slow but straight road to becoming a province and are deprived of a chance to head to prosperity.

 

So far each country has survived by having found ways of efficient and effective taxation for itself, as tax analyst Alan Reynolds noted at the conference on taxes organised by the LFMI in as early as 1997, by having found the least painful way to skin a cat. There is no way one can deny the existence of fundamental country differences (mentality, traditions, income, a geographic and historical position), neither can one deny or change the phenomenon of taxation, so what is left to do is to tolerate different taxes and consequently tax competition in hope of having efficient taxation. Any resistance to this reality, imagining things rather than facing the reality makes harmonisation either inefficient or simply impossible.

 

All the efforts to align taxes meet huge technical challenges in both making decisions on tax uniformity and implementing them.

 

All the previous conclusions about the existence of competition, let's call them lessons, are addressed to the European Union willing to harmonise and to Lithuania willing to obey. My conclusion, which will come at a later stage of my presentation, will also be addressed to both Lithuania and the European Union, and I would like to call them challenges to harmonisation. (In fact, I might give my contribution a different title "Lessons of competition. Challenges to harmonisation. To Lithuania and the European Union").

 

I have already noted that competition is an existent fact. Beside tax competition we might talk about a certain tax segment harmonised in a certain area. The challenge is posed, what are the responses?

 

It would be only too naïve to think that if indirect taxes were harmonised in the European Union, competition would be eradicated. Of course, not. First, it would penetrate into other taxes. Second, competition between a taxed economy and an untaxed (shadow) economy would be more severe. Third and most important, the area of competition is the whole world rather than Europe or the European Union only. A closed and uniform Europe could be a discussion item when the world was divided and closed by what may be called physical walls, when no physical, technological, informational possibilities for moving in space and time existed. There are different attempts made to localise and tax e-commerce and trade in derivative securities. But all the attempts are hopelessly lagging behind progress in the field of globalisation. Technologies, in this instance, serve for the purpose of realistic globalisation, and maybe, for the better, and maybe, for the worse, impede surrender and obedience to harmonisation.

 

Choosing from between fight against progress and world-wide movement, on the one hand, and acceptance and realisation that the more diversified choices there are in the internal space, the smaller is the need to look for them outside, on the other. This is an important challenge to harmonisation. And now, the more progress is made in uniformity or synchronisation of taxation, the greater will the pressure to choose either - or… Either stay in the area or withdraw as the area of choice narrows. The European Union vitally needs competition in its area for the Union to be able to compete globally in trade, investment, i.e. economic activity area.

 

Listening to my presentation, you might get an impression (or you must have already got an impression) that I am definitely against harmonisation. I am trying to prove that competition is a smart guy, and that harmonisation is faced with lots of challenges. So now I have come to the point when I want to destroy the possibly wrong impression because I have nothing against harmonisation, and I want to explain against what particular harmonisation I am not against.

 

When Friedrick A. von Hayek argues about social order, he mentions two patters of social order "an imposed order" and "a grown order", or "coerced" (sometimes even military) and spontaneous, or taxis and kosmos. And even though Hayek tells about these orders in a broad legal context, these two patterns of order or the way they become prevalent can be successfully applied to tax law.

 

In reality all the talking about a different or the same tax environment moves to another field. We are not talking about an end, all the results will be, most probably, accepted in the end if they are obtained by way of natural and non-coercive development. The same applies to taxes too, absolutely the same taxes would be acceptable if each country found, introduced and retained them in its own way. Such an instance of spontaneous harmonisation is fully possible, realistic and real. Let's glimpse at the tax systems of different states, all of them have followed a similar evolution. The method must have been that of copying when some countries would take on board other countries' systems. If they proved to be appropriate there, they would be retained, if they did not, they would be rejected. For that reason all the countries have income tax, and do not tax windows or beards. This does not mean that the similarity of taxes has been decided upon and commanded, what I suggest is that the process was spontaneous. It has been dictated by need (whether the need is reasonable is another story) rather than the declaration of a uniform tax regime. There is just one general argument against spontaneous tax harmonisation - a shortcoming typical of all the methods - spontaneous tax harmonisation is implemented by a government, but with only a small degree of certainty that it will not decide to expand "spontaneously". A spontaneous development and competition of governments provides more choice for people and by doing so limits government arbitrariness.

 

May the harmonisation undertaken by the European Union be called spontaneous, or should it be labelled "coercive"? Evidence of spontaneousness is in accession, which is voluntary, hence the result of choice. However, the key is the internal policy of the European Union and its attempt to raise an issue of harmonisation. As I mentioned at the very beginning when I dwelt on the aims of harmonisation, the single (unified) Europe implies, beside other things, that it is the same all over. Non-acceptance of differences, wish to have in birds of a feather that flock together - this is an attribute of a coercive order. And there comes one more challenge to the European Union - how much can the declared economic values as well as political rights be realistically ensured. The future of Europe will depend on how this challenge is met. Larger doses of spontaneous order, which in no ways does not mean 'no order', would be in the interests of the Union itself.