The own resources of the European Union : analysis and possible developments.
Date: 1999-01-01
Institutions: Directorate-General for Parliamentary Research Services
Subjects: EU Member State, GNP contribution, VAT resource, budgetary resources, environmental tax, excise duty, own resources, tax on income

This publication is available in German, English and French.  The Executive Summary is available in 
all languages. 

External Study 
This study  was carried out  by  Ian  Begg,  Nigel Grimwade and Peter Price,  with Eamon Lally -
Business School,  South Bank University,  103 Borough Road, London SE 1 OAA. 

The  opinions  expressed  in  this  publication  do  not  necessarily  reflect  those  of the  European 
Parliament as an institution. 

Reproduction and translation for non-commercial purposes are authorized provided the source is 
acknowledged and the publisher is given prior notice and sent a copy. 

Publisher: 

EUROPEAN PARLIAMENT 
Directorate-General for Research 
L-2929 LUXEMBOURG

Editor:  THOMAS BOHNE 

Division for Budgetary Affairs, the Rules of Procedure, Civil Liberties, Petitions and 
Legal Affaires 
Tel. (00352) 4300-22470 
Fax (00352) 4300-27728 

Manuscript completed in September 1997 

EUROPEAN PARLIAMENT 
• 

Directorate  General for Research 

WORKING DOCUMENT 

THE OWN RESOURCES OF THE EUROPEAN UNION: 
ANALYSIS AND POSSIBLE DEVELOPMENTS 

' 

Budget  Se ri e 
W-4
09-1997

This publication is available in German, English and French.  The Executive Summary is available in 
all languages. 

External Study 
This study  was carried out  by  Ian  Begg,  Nigel Grimwade and Peter Price,  with Eamon Lally -
Business School,  South Bank University,  103 Borough Road, London SE 1 OAA. 

The  opinions  expressed  in  this  publication  do  not  necessarily  reflect  those  of the  European 
Parliament as an institution. 

Reproduction and translation for non-commercial purposes are authorized provided the source is 
acknowledged and the publisher is given prior notice and sent a copy. 

Publisher: 

EUROPEAN PARLIAMENT 
Directorate-General for Research 
L-2929 LUXEMBOURG

Editor:  THOMAS BOHNE 

Division for Budgetary Affairs, the Rules of Procedure, Civil Liberties, Petitions and 
Legal Affaires 
Tel. (00352) 4300-22470 
Fax (00352) 4300-27728 

Manuscript completed in September 1997 

Catalogue number: QA-BU-DG-W04-EN-N

( 

EUROPEAN PARLIAMENT 
• 

Directorate  General for Research 

WORKING DOCUMENT 

THE OWN RESOURCES OF THE EUROPEAN UNION: 
ANALYSIS AND POSSIBLE DEVELOPMENTS 

.  ' 

Budget  Se ri e 
W-4
09-1997

The own resources of the European Union: analysis and 
possible developments 

Executive summary 

Since  1988,  the  European Union (EU)  has  been financed by  a system in  which  four  'own 
resources' provide the revenue needed to meet its expenditure commitments. Own resources, 
in  principle,  are  tax  instruments  which  are  assigned  directly  to  the  supranational  level  of 
government and are not, as a result,  subject to decisions by the Member States. The legal base 
for this is Article 201 of the EC Treaty, as amended by the Treaty on European  Union. 

11 

Two of  these  resources  - agricultural  duties  and  levies,  and  customs  duties  (known  as the 
'traditional own resources') - are assigned exclusively to the EU, but raised just 17.2% of the 
total in the 1997 budget. The third - the VAT resource - apportions a share of \if ember States' 
receipts from VAT to the EU, after allowing for differences in VAT coverage.  This resource 
has been the principal source  of EU revenue latterly, although its share declined to 42% this 
year. The fourth resource - calculated on the basis of Member State GNPs - is called upon when 
the proceeds  of  the  first three are insufficient to finance the budget.  It has accounted for an 
increasing share in recent years, rising to 40% in  1997, and is set to increase further. 

m  This system  of financing will continue  for  the  next decade  if the plans put  forward  by the 
European Commission in Agenda 2000 are adopted by the EU.  It has the conspicuous quality 
that it works.  In  spite of this,  the current  arrangements for financing the EU have attracted 
criticism because: 

• Notwithstanding  Article  201,  neither  the  VAT  resource  nor  the  GNP  resource  can
accurately be described as being 'owned' by the EU, but are,  instead,  effectively transfers
from the Member  States.

• Citizens cannot easily identify the taxes paid to finance EU expenditure.

• The share of revenue from the two traditional own resources is expected to fall further,
while,  with  a  cap  applied  to  the  VAT  resource,  the  share  of the  fourth  resource  will
continue to grow. This will take EU financing more towards a block grant system, rather
than genuine own resources, and can be expected to prompt other Member States to argue
for abatements similar to that enjoyed by the UK.

• As the  EU  deepens  with EMU and is  enlarged  to incorporate new Member States from

central and eastern Europe, new pressures on the budget can be anticipated.

1v  A new financial perspective is due to be negotiated shortly,  so that an appraisal of the funding 
side of the budget is also timely.  This will take place against a backdrop of a crowded agenda 
for change in the EU. For many, therefore, any attempt to reopen the debate on own resources 

would  be  a  step  too  far.  The  fact  that Agenda 2000 argues for retention  of both  the own 
resources ceiling of 1.27% of GDP and for no change in the system testifies to this. 

v 

v1 

Equally, it is argued that the EU has eventually to confront the inconsistencies and drawbacks 
of the present system. Despite the difficulties that have been experienced in previous attempts, 
a search for new own resources is, consequently, warranted. 

This report reviews the development of own resources since their formal introduction in  1970 
and considers how the system might evolve. Criteria for assessing potential own resources are 
developed and  then used  to  evaluate  eight  possible  options.  These are  then  compared  and 
proposals for the development of EU financing are laid out. The eight options considered are: 

• A surcharge on income tax
• A European withholding tax
• A European corporation tax
• Modulated value added tax
• Environmental/energy tax
• Alcohol and tobacco excises
• Using seigniorage revenues
• New 'communications' taxes

vu  The criteria used to appraise these draw, in part, on theoretical work on taxation, but have also 
been  designed  to  reflect  the  political  and  institutional  context.  Three  sets  of criteria  are 
employed, covering economic, administrative and political considerations: 

• The economic criteria include issues of equity and economic efficiency, modified to take

account of the circumstances of the EU

• Administrative criteria highlight the importance of assuring the stability and buoyancy of

the revenues,  as well as factors such as limiting fraud or evasion.

• In identifying political criteria, the aim is to take account of the many sensitivities that need
to  be  accommodated and  to focus on  key attributes that any new own resource  has to
exhibit, for instance, visibility.

vm  There will inevitably be disagreements about the relative importance of different criteria and 
of how  well  or  badly  any  proposed  tax  'performs'  on  them.  Nevertheless,  a  transparent 
methodology for scoring the different options is explained in the report and employed to obtain 
a quantitative score for each of the options. This is based on assigning a common weight to 
each criterion,  then  ranking the proposed own resource on a five point scale running from 
strongly favourable to strongly adverse. A score is then computed by multiplying the weight 
by the ranking and summing across the criteria. 

1x 

This procedure suggests that modulated VAT and communications taxes are the most attractive 
candidates at present. However, if current policy initiatives - notably in relation to advancing 
the single market - bear fruit, some of the obstacles that count against corporation tax can be 
overcome. Similarly, global negotiations might open the way to an eco-tax.  Such developments 

ii 

Box  1.1: What are own resources? 

To finance its expenditure the European Union has its own resources, essentially tax instruments 
which Member States have agreed to assign to the Union .. At present there are four own resources 
as shown below.  The first two have been in place since 1971; a system of VAT resources w� 
finalised in  1979; the fourth or 'additionar resource was introduced in I 988. 

I. Agricultural duties, and sugar and isoglucose levies

Agricultural duties replaced agricultural levies from July 1995.  Sugar levies are still 
charged in the form of sugar market arrangements to cover market suppon expenditure 
and the costs of storage ( ensuring a regular flow of sugar on the market). 

2. Customs duties.

The Common Customs Tariff is applied to the customs value of goods imported from 
countries outside the European Union. 

3. VAT resource

A proportion of VAT in each country's harmonised base.  This is currently 1. 4 % but will 
decrease to 1 % in 1999.  In addition :r Member State· s base may not exceed 55% of its 
GNP (decreasing to 50% in 1999). 

4. The fourth resource

Created in  1988 to balance the budget.  The fourth resource is based on GNP and is 
derived from the application of a rate to the sum of the GNPs of all the Member States 

Revenue from agricultural duties and customs duties remained fairly constant between 1980 and 
88,  as is  shown  on  the chart below, but has fallen consistently as a percentage of the total. 
Revenue from VAT resources increased rapidly following its introduction in 1979 but has now 
levelled off.  Revenue from the fourth resource has risen significantly since it was introduced in 
1988, as its purpose is to make up for any shortfall in revenue raised by the first three resources. 

Figure  la: Community Re�nue (BECU) 

I 00  .,...........,..,.........,.,,............,, __ ._ __ ,.,.,,..,,...,............,....,...,.,......,,,.,,.,.....,,,,,_.,.,,.,.,,,......,...,,..,,..._,...,...,__,...,,.,,,.._,...,..,,....,...-..,.,....-,--.,,...,--,--. 

80  ·il;ff1m "il:ll!!f IIlmrn .miitili !�;!i!l;; m�rnli :iil!::m t;;m.11; ll.rmi!.ll I�;llllll :l!lfMl f,t,:l:li�i ililliil:l mmm: ;tE
:m:tmr ��l:!:llrn,;: :j:l1Jtm t1!:1:1m l.!.:0f!.i!i i�!Ji�l: iWml:: ti��li lli=;!.mll :imm:I fA�g:! ri/fftm ·,�ttt ·0wrr ;.)-:•>'-" ·-
t·ti-¥:!; ;::�;:�11 :!:����:�\ _'.����tf:-:� i:mm: ::R> =\UH ww:== · 

60 

40 

-
8 

20 

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00 

00 

-.:: 

"'  e,  "'  "'  "'  "'  "'  -.:: "'  "'
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■ Agric dUiics  II C!Stoms dUiics  ■ VAT  II GNP resource  □ Miscellanea� 

,.,  .,,.  .,., 
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....  00 
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Source: South Bank University; data:  ff: 

2 

In panicular, and despite Article 201, neither the VAT resource nor the GNP resource can 
accurately be described as being 'owned'  by the EU. In practice, they are more like grants 
from the Member States. Moreover, the proportion of total revenue generated by the first and 
second resources (also known as the traditio1:1al own resources) has fallen steadily and will, 
as the figure in box 1.1 shows, only account for about 17% of total revenue in 1997 . 

• 

I. 7  Among the other criticisms of the own resources system two are worthy of note. First. the
lack of visibility of these taxes for the citizen makes it difficult to demonstrate a clear link 
between EU policies and the taxes raised to finance them.  Second, there is a perceived lack 
of accountability which derives from the purely consultative role of the European Parliament 
(EP) in determining sources of revenue. Unlike most other Parliaments, the EP has a co­
decision  in  expenditure  but  not  in  revenue  raising - what some commentators  regard as 
representation without taxation, to invert a well-known aphorism.  The EP has argued that 
the present arrangements fall a long way short of being a genuine system of own resources 
capable  of  providing  the  Union  with  the stable  source  of  finance  necessary  to  meet  its 
responsibilities. 

I . 8  For all these reasons, efforts to develop the system of own resources have been prominent 
on the EU agenda. The EP, for example, has called upon the Council to consider the creation 
of  a new  own  resource  to  replace  elements  of  the  existing  system  (specifically,  VAT 
payments and GNP-based contributions) which is better able to meet the requirements of a 
genuine own resources system when the current financial perspective expires in 1999. 

I. 9  The Commission, in its proposals to the Council of Ministers in March  I 992 ( the so-called
Delors  II  package),  cast around unsuccessfully for a  new  tax  to be used.  The  view  was 
expressed  that  the existing third and  fourth resources  were  perceived  by  Member  State 
governments as being budgetary contributions.  This compromised the independence of the 
EU, creating uncertainty about the level of resources likely to be available, and undermined 
democratic accountability as no visible link existed between what was paid in taxes and what 
was spent at the Union level. While acknowledging that it had failed to find any obvious 
candidate  from  within  the  existing  tax  systems  of  the  Member  States,  it  undertook  to 
'promote  the necessary conditions  allowing for the creation of such  a  resource'.  (CEC, 
1992). However, it envisaged any new own resource being added as a fifth res·ource. 

Possible del,elopments in own resources 

1. 10  The 1994 own resources decision commits the Commission to review the financing system
in 1998 and, possibly, to come forward with proposals for new own resources (Article 10). 
However,  as noted above,  the proposals in Agenda 2000 suggest that no change will be 
proposed,  and it is clear from interviews conducted in the course of this study that there is 
a  lack  of  political  will  to  seek  change.  Thus,  for  a  variety  of  reasons,  there  has  been 
resistance to any significant evolution in own resources since 1988 when the GNP (fourth) 
resource  was  introduced.  This  inaction  highlights  the  difficulties  in  identifying  a  tax 
insnument that is simultaneously equitable, sufficiently independent of the Member States, 
yet which provides a direct link between what the Union spends and the amount paid by the 
citizen in taxes to cover costs. 

3 

1.11  In its most recent proposals for a new  'Financial Framework'  beyond the existing Financial
Perspective expiring in 1999,  the Commission has come out against the introduction of any 
new own resource and proposes �e hold the existing ceiling on own resources ( of 1.27% of 
GNP) for the period 2000-2006. It sees technical and institutional obstacles arising from the 
creation  of a  new  own  resource  without  succeeding  in  the  objective  of  increasing  the 
financial autonomy of the Unipn. The latter could only be achieved if the  entire budget were 
financed by  'autonomous fiscal resources',  a prospect to which there is  little  chance of the 
Member States agreeing.  It also argues that the current arrangements, which place a limit on 
VAT  payments  by  countries  with  low  per  capita  incomes  and  in  which  an  increasingly 
important role is now played by contributions based on GNP,  has gone a long way towards 
creating greater equity between the Member States.  Taking into account both  the arguments 
for and against,  it comes down in favour of retaining the status quo. 

1.12  We argue that, in the longer-term,  the current arrangements are likely eventually to require 
modification and that there are worthwhile alternatives to the present system. Although it is 
most  improbable  that the  Council  would  contemplate  more  expansive  proposals  for  the 
budget  than  those  put  forward  by  the  Commission,  the  transition  to  full  economic  and 
monetary union in the next century must be expected  to add to pressure� fr-,. some  expansion 
in the size of the budget in relation to  EU GNP (as signalled in the MacDougall Report of 
1977), and would require additional own resources. If the experience of other federations is 
a guide, this will necessitate some re-assignment of taxes as between the Member  States and 
the  EU  level. This  could be  achieved  either  by  sharing the revenues from  certain taxes or 
agreement by the Member  States to assign a tax directly to the EU tier. 

1.13  Any new  own resource(s) must fulfil quite demanding criteria,  particularly  in the  light of 
demands from the Member States for  equity.  However, it should also be recognised that the 
problem  is not  merely a revenue  one,  as  unfairness  in  the  budget arises  mainly from the 
spending side. If,  therefore,  the budget is to be used to bring about redistribution of funds 
from richer to poorer Member  States,  this should be addressed by adjustin g  the manner in 
which EU funds are spent as well as increasing reliance on revenue sources which are related 
to ability to pay. 

Content and structure of this report 

1.14  The purpose  of this Report is to provide  an  evaluation of the own resources system  of the 
European  Union  as  it  has  evolved  over  the  twenty  seven  years  since  the  Luxembourg 
Agreement ( 1970)  and to  consider options for its reform. The background to the Report is 
the long-standing concern expressed on several occasions by the EP concerning the adequacy 
of the existing arrangements. 

1. 15  Various options for reform of the own resources system are discussed in detail. Many of the
'candidate'  instruments  have  been  discussed  in  previous  work,  an  example  being  the 
Commission study Stable Money,  Sound Finances (CEC,  1993). Although reservations will 
always  be expressed about particular measures,  it is important to  examine the  merits  and 
demerits  of each  to  assess  its  worth.  It  is  also  necessary  to  devise  objective  criteria  for 
comparing potential instruments. 

4 

1.16  In preparing this Report,  we consulted several Members of the EP as well as experts from 
the Commission,  the  Council,  academia and some Member States. The purpose of these 
discussions  was  to  solicit  views  on  the  strengths  and  weaknesses  of  the  existing 
arrangements,  the possibilities for reform,  and the institutional and political feasibility of 
different options for the development of the system of own resources. These expert views, 
which  provided  very  valuable  insights  into  the  scope  for reform  of  the  system  of own 
resources,  have  been  taken  into account in  muc�  of the  analysis which  follows,  but  are 
neither explicitly reported, nor attributed to individuals. 

1.17  The remainder of this Report is in six parts. Section 2 sets out the current arrangements for 
the  revenue  side  of  the  Budget  and  discusses  the  adequacy  or  otherwise  of  these 
arrangements.  Section 3  provides  an  overview of  the historical development of the own 
resources system from  its  inception in  1970 through to the present day. In section 4, the 
criteria to be used in assessing potential own resources are explained. An extended discussion 
of eight possible options is then presented in section 5. These are then compared in section 
6. In  the  last  section,  we  summarise  our  results  and  make  our  recommendations.  A
bibliography  and  glossary  are  provided,  together  with  three  annexes  which  present,
respectively, fuller accounts of the historical development of own resources, of the theory
of fiscal federalism and of the legal base for own resources.

' ,. 

5 

2  The own resources system: its strengths and weaknesses 

2.1  Most analyses of tax assignment (see, for example, the comprehensive work by Messere, 
1993 ), regard central government, whether in a unitary or federal state, as being at the top 
of the fiscal hierarchy, with regional and local governments lower down. Yet, in terms of its 
autonomy in fiscal matterS, the position of the EU in revenue-raising is, in many ways, more 
akin  to  local  authorities.  It  is  obliged  to  balance  its  books  year-by-year,  the  principal 
democratic forum - the EP - has only consultative rights in relation to revenue-raising, and 
it  is  the  Member  States  which  dictate  which  tax  instruments  are  to  be  assigned  to  the 
supranational tier. Rather  than being a conventional hierarchy as found  in federal states, 
therefore, tax assignment in the EU is more a 'middle-up and middle-down'  system. 

2.2  The current system for financing EU expenditure has one conspicuous  quality:  it works. 
Despite  the  various  criticisms  alluded to in the introduction,  any  attempt to change the 
system is bound to come up against the reasoning that 'if it ain't broke don't fix it'. This 
argument is already apparent in the unwillingness in so many quaners to re-open the question 
of own resources.  It is given added force by the crowded agenda confronting the EU over 
the ne;,."t two years, notably the start of EMU, enlargement negotiations and the new financial 
perspective.  With  so  many  other  potentially  contentious matters  to  resolve,  there  is  a 
sentiment that if, to use a sporting metaphor,  own resources can be kicked into touch, then 
so much the better. 

2.3  Equally, there are sound reasons for wanting the EU to have its own resources and to ensure 
that  these  have  desirable  properties as tax  instruments.  Despite the formal  provisions in 
Article 201, there is a general acknowledgement that the financing of the EU is,  in essence, 
a system  based  on  inter-governmental  transfers,  rather than one in which the EU tier of 
government has its own sources of revenue. This is seen as contrary to aims of transparency 
in EU affairs,  and against the .commzmautaire spirit.  Moreover, given that many countries 
see advantages in giving local government ownership of certain taxes, precisely because this 
establishes a channel of accountability between electors and elected, a strong case can be 
made that similar arrangements should apply for the EU. 

What are own resources? 

2.4  Perhaps surprisingly, the Treaty does not define own resources. These are generally taken 
to mean the sources of revenue which the Member States have agreed should belong to the 
Union rather than the Member States - what a Commission publication on the  Union budget 
defines as 'tax revenue allocated once and for all to the Union' (CEC, 1997) although the 
Member States retain responsibility for levying and collecting the taxes. An essential feature 
of an own resource is that it: 

'accrues to the Community budget automatically, without depending upon  any year­
by-year decisions to be taken by national budgetary authorities' (Padoa-Schioppa, 
1987). 

In short, own resources confer financial autonomy on the budgetary authority, so that it is 
not reliant upon the willingness of the Member States to provide the necessary funds. 

6 

2.5  Where  the revenues from a particular tax  are  shared between the  Union and the Member 
States, the arrangements (and any alteration in these) require the agreement of the Member 
States. Without financial autonomy,  medium-term spending cannot so easily be planned,  as 
the revenues year-by-year are not  assured.  A further important attribute of a genuine own 
resource is that the individual taxpayer should be able to identify the proportion of earnings 
or spending which is paid in taxes to the EU rather than to the Member State. 

2:6  This can be achieved either by assigning a particular tax exclusively to the EU or by making 
a proportion of  any tax levied by the Member State directly payable as a Union tax.  In the 
latter case, however, the amount paid by the Member State to the Union must be equivalent 
to  the  amount  collected  directly  from  the  taxpayer  and  not  based  on  some  subsequent 
statistical calculation which may not bear any direct relationship to what the taxpayer has 
paid.  Any  increase in  spending  at  the  EU  level  should  then  translate  into  an  equivalent 
increase in the amount of tax paid by the individual taxpayer. 

2. 7  The  1970  Luxembourg Agreement designated as own resources the agricultural and sugar
levies (renamed  post Uruguay Round  as  'duties') imposed on imports from non-Member 
States under the Common Agricultural Policy, customs duties collected from the operation 
of the Common Customs Tariff on imports from non-Member  States and a percentage (not 
greater than  1%) of Value-Added Tax (VAT) applied to a uniform assessment base.  In 1984, 
the maximum percentage of VAT which could be collected by the  Union from the Member 
States was raised to  l .4%. 

2. 8 

In 1988, a new (fourth) GNP-based resource was created, while VAT payments were capped
at 55% of the GNP of any  Member State with a per capita GNP 90% below the EU average. 
In 1992,  it was agreed that the VAT call-up rate would be progressively lowered from 1.4 
to  l % in equal steps over the period  1995-9. At the same time, the ceiling on VAT payments 
for countries  with  a per capita  GDP below 90% of  the EU average was lowered  to 50%. 
Matters are further complicated by the practice of distinguishing between 'traditional own 
resources'  ( customs duties and agricultural levies) and other own resources. 

The four resources assessed 

2.9  Customs and agricultural duties do constitute own resources.  In each case,  the whole of the 
tax belongs to the Union, although the Member  States currently retain a proportion of the 
revenue to cover the costs of collection and administration.  However, the importance of both 
sources  of  revenue  has  been  declining  as  a  proportion  of  total  own  resources.  This  is 
illustrated  in Figure 1.1. Whereas in 1980,  traditional own resources accounted for nearly 
one-half of all revenues, it is estimated that,  by 1997,  their share will have fallen to 17%. 

2.10  The reasons for this are well known.  Although the value of imports increases year by year, 
the  Union's  Common  Customs  Tariff  has  been  progressively  lowered  as  a  result  of 
multilateral trading agreements.  At the same time, the extension of trading preferences to 
non-member countries which have signed trading agreements with the EU and to developing 
countries which benefit from generalised preferences has reduced income from this source. 
Agricultural  duties  are  affected by the decline  in importance of food imports in  total EU 
imports. Moreover, any tendency for EU intervention prices to fall closer to world prices (as 

7 

was provided for in the MacSharry measures in  1992 and is envisaged in the Commission's 
latest proposals for CAP reform) will further reduce the income from this source. It follows 
that the share of traditional own resources in total revenues is certain to fall further. 

2.11  It is, however, difficult, to portray the third and fourth resources as being 'owned' by the EU 
in  the  sense  described  above.  The  problem  with  VAT  is,  in  part,  the  method  used  to 
determine the payments of Member States. When the VAT own  resource first  came into 
being following the Luxembourg Agreement and the subsequent agreements on a harmonised 
base, Member States were free to choose between two methods of determining their VAT 
assessment:-

• The returns or base-on-base  method which, as the name implies, is based on the actual

VAT returns received from taxable persons during a given year

• The  revenue  method whereby the VAT  base is determined by dividing  the total  net
revenue collected by an average weighted rate representing the VAT rates applying the
Member State concerned.

The original intention was that the VAT assessment should be based on actual VAT returns 
as the only method which could deliver a visible and direct link between the Union and the 
taxpayer. However, the Member States maintained that shortcomings in their VAT returns 
rendered  the  first  method  unworkable  and  that  only  the  revenue  method  could  ensure 
payment of own resources without excessive delay. As a result, the amount of VAT paid by 
the Member States has borne increasingly less relationship to the notional  1 % VAT call-up 
rate. 

2.12  Further  problems  arose  because  of  the  budgetary  adjustment  system  introduced  at 
Fontainebleau  in  June 1984  to correct Britain's  'excessive'  net  contribution.  Under  this 
special arrangement, the UK's VAT contribution is reduced by an amount equivalent to 66% 
of the difference between its share of VAT payments and its share of expenditures allocated 
for the year in question. The 'abatement'  for the UK is paid from the VAT contributions of 
the other Member States such that their contribution to the spending side of the budget is 
below the maximum call-up rate of 1 .4%. 

2.13  An added complication is that Germany's share of the cost of the British rebate was 'capped' 
at two-thirds of its VAT share3
.  These adjustments mean that  there exists  no direct link 
between the 1 % VAT which Member States are required to pay to the EU and the level of 
VAT paid by consumers in individual Member States. Indeed, the linkage has de facto been 
further undermined by the fact that, starting in 1988, VAT  payments for Member States with 
a per capita GDP below 90% of the EU average were 'capped' at 55% of their GNP before 
1992 and then at 50% since. 

2.14  The fourth,  GNP-based resource is essentially a residual payment intended to cover any 
deficiency in resources after revenues from traditional own resources and VAT have been 

3  As one Member  of the EP we consulted points out. this means that there are.  in practice. three

different regimes in operation tor calculating Member Stares· s VAT contributions. 

8 

collected.  It, therefore,  bears no relationship to  any specific tax borne by the taxpayer.  Its 
main advantage, however, is that it provides a relatively buoyant source of revenue and one 
that it is related to the ability of a Member State to pay.  An important unresolved issue 
concerns whether  GNP  should  be  calculated  using market  exchange-rates or  purchasing 
power parities. Since market exchange-rates fluctuate in response to a variety of factors, the 
preference must be for the 1¥?:er. 

Drawbacks of the 3rd and 4th resources 

2.15  A general criticism of VAT is that, unlike GNP-based contributions, Member State payments 
are affected by several  influences which give  rise to inequities. The first is that, since the 
incidence of VAT is only on the private consumption of goods and services, Member States 
that  have higher ratios of private consumption spending to GDP make larger payments. 
Secondly, countries with high ratios of spending on public goods and services end up with 
lower VAT payments. Finally, because the EU still operates a 'destination approach' for the 
collection of VAT, the system benefits countries which are net exporters of manufactures. 

2.16  These considerations cast doubt on the suitability of VAT as an own resource for the EU, at 
least  as  currently  applied.  It is,  however,  interesting  to  observe  that,  as we demonstrate 
below, VAT is not as regressive a tax as is commonly assumed. Rather, the evidence suggest 
a strong correlation between Member States'  per capita VAT payments to the EU and GDP 
per capita. One reason for this is the cap which has been placed on the VAT payments of the 
less-favoured Member States since  1988. 

2.17  Although an own-resources ceiling  based on GNP rather than private consumption should 
provide a more buoyant source of revenue, the fact that own resources are controlled in this 
way has other drawbacks, as the EP has argued (See the Langes Report (EP,  1994)). One is 
that revenue flows are affected by cyclical swings in the level of economic activity. If GNP 
falls,  revenues are  reduced. Because the  EU  has  no powers to borrow,  spending must be 
reduced. By contrast, if the GNP of  an individual Member States falls, it is rare that public 
spending is cut. Instead, borrowing is undertaken to ensure stability in the cyclically-adjusted 
budget  deficit.  Furthermore,  the  ceilings  render  medium-term  planning  �f  spending 
problematic. 

2.18  These  problems  arise  because  the  Union  remains dependent  on the Member  States for 
financial contributions rather than having any genuine resources of its own. It is estimated 
that 42% of own resources will come from VAT and 40% from GNP-based contributions 
in  1997.  In  other  words,  the  Union  remains  dependents  on  contributions  which  are 
effectively  inter-governmental  transfers  from  the  Member  States for  the majority of  its 
revenues.  Moreover,  the  share  of  the  GNP-based  own  resource,  which  bear  the  least 
relationship to own resources, is certain to increase further in the future. 

9 

• An increase in the maximum VAT call-up rate from  I% to  1.4% to take effect from  1st
January,  1996. (In  1984 and  1985, extra funds had to be made available to make good
the deficiency in revenues and meet spending commitments).

• A  further  possible increase of the maximum VAT rate to  1.6% on  I st January  1988
subject to a unanimous agreement of the European Council. It was envisaged that the
1.4% VAT ceiling would prove inadequate to meet future commitments (in particular,
the  accession  of Spain  and Portugal)  and  would  therefore  need  to  be  raised  again.
However, this would require the assent of all the Member States.

• A budget adjustment system was agreed for the UK. For  1984,  the UK would receive
a one-off  ECU  1  billion (approximately £600 million) rebate equivalent to about 50%
of its net contribution.  From  1985  onwards, it would receive  66% of the difference
between its share of the VAT payments and its share of expenditures allocated for the
year in question. (The reason for this formula was the view of other Member States that
traditional own resources should not be included in the calculation). It was agreed that
these refunds would continue until any further increase in the VAT ceiling was agreed
upon. In addition, Britain's 1983 rebate of ECU 750 million (£440 million) which had
been temporarily frozen was released.

• An agreement in principle that any Member State expected to sustain a budgetary burden
considered excessive in relation to its relative prosperity could be entitled to a correction
at  the appropriate time.  This would be determined,  as  in the case of the UK,  by  the
difference between its share of VAT payments and share of expenditure.

• The cost of the UK rebate to be shared out among the Member States according to their
normal VAT share. However, a ceiling was placed on Germany's share equal to two­
thirds of its VAT share.

3.6  The Fontainebleau Agreement proved, almost immediately, unable to generate sufficient 
revenue for three main reasons. First, traditional own resources - agricultural levies, sugar 
levies and customs duties - were declining. Between  1982 and 1988 the percentage of own 
resources made  up  of agricultural  and sugar levies  halved,  while  the  perce�tage  from 
customs duties declined from one third to one quarter. These declines ensured that the new 
maximum VAT ceiling of 1.4% was reached in its first full year. Second, the VAT base was 
growing at a slower rate than economic activity generally, because of a reduction in the share 
of private consumption in total GNP. Third,  the budget adjustment mechanism agreed in 
respect of UK contributions reduced the effective VAT call-up rate from 1.4% to 1.25%. The 
reason for this was that the cut in Britain's VAT contribution was paid for by an increase in 
the VAT contributions of other Member States up to a maximum of 1.4%. The effect was 
to bring do;wn the uniform rate as applied to all Member States to  1.25%. 

3.7  The  problem  of inadequate revenues was  compounded  by  rising  spending commitments 
which had only in part been anticipated. Despite the measures agreed by the Farm Ministers 
in March,  I 984,  agricultural spending began to grow faster than before. Partly, this  was 
caused  by  the  entry  of Spain  and Portugal  whose agricultural output  added  to existing 
surpluses in•certain sectors. Partly, too, it was caused by a fall in world commodity prices 

11 

combined  with  a  decline  in  the  value  of the  US  dollar which raised  the  cost  of export 
subsidies. The 1 .4.%  VAT ceiling was reached in both 1986 and 1987, a crisis only being 
forestalled by a variety of anificial devices on the spending side including a delay in the 
payment of agricultural advances under the EAGGF. 

Brussels: 1988, the cu"ent system 

3.8  Fresh proposals for changes to the Union's own resources system were considered by the 
European Council meeting in Brussels on 11-13  February  1988. The Bn,ssels Agreement 
adopted most of the proposed changes with some differences: 

• A ceiling for the Union Budget was agreed of 1.2% of GNP for payments and 1.3% for
commitments up to 1992. This was  less than the 1.4% proposed by the Commission.
(The new 1.2% ceiling for payments was equivalent to a ceiling of between 1. 9-2% in
VAT terms).

., . 
..,  9 

In  providing the  Union  with increased finance to meet its expenditure commitments,  the 
Brussels Agreement was a success. The actual 1988 payment appropriations represented just 
1.11% of GNP, 0.01% below the allowed ceiling. This gap increased in 1989 to 0.04% and 
the  financing  required  in  1990  was  0.2%  below  that  anticipated  in  the  1988  Financial 
Perspective.  Essentially there were two  reasons - reductions in EAGGF expenditure and 
faster economic growth in the Union. This last factor also had the effect of increasing the 
VAT base and as a result the need to tap into the fourth resource was less than anticipated. 
In consequence,  the environment in which proposals were put forward in respect of own 
resources for the period after 1992 was substantially different from  that which preceded the 
Brussels Agreement. 

Edinburgh: 199 2

3.10  At  the  Edinburgh meeting of Heads of State and Government of 11-12 December  1992, 
arrangements for own resources for the seven year period up to end-1999 were announced: 

• Intermediate annual ceilings were laid down for payment appropriations of 1.15% in
1988,  1.17%  in 1989,  1.18% in 1990,  1.19%  in 1991 and 1.2% in  1992.  (Payment
appropriations determine the actual amounts of revenue of the Member States).

• A budgetary ceiling increasing from 1.2% of GNP in 1992 to 1.27% in 1999 was agreed.
This was a lower ceiling than that proposed by the Commission and spanned  a seven­
year period instead of jive years.

• Intermediate annual ceilings on own resources for payment appropriations were agreed
as  follows:  1.2% in 1993 and 1994, 1.21 % in 1995,  1.22% in 1996, 1.24% in 1997,
1.26% in 1998 and 1.27% in I 999.

• The ceiling on the VAT call-up rate was to be reduced from 1. 4% to 1. 0%, in equal steps

over the period 1995-1999.

• For Member States with a per capita GNP of less than 90% of the community average,
the assessment base for VAT payments was to be  limited to 50% of a Member State's
GNP.  This  change  would  also  be  introduced  in  equal  phased  steps  over  the  period
1995-1999.

. ,. 

• The  maximum  call-up rate for VAT  was  maintained at 1 .4% (not reduced  to  l % as
proposed by the Commission). However, the VAT base for the purposes of determining
VAT payments was not to exceed 55% of the GNP for any Member State with a per
capita GNP 90% below the EU average. This mainly benefitted Ireland, Luxembourg
and the United Kingdom in 1988, and Portugal and Greece in 1989.

• The  proposal  to replace  the  harmonised  with  the  actual VAT  base  for  purposes  of

assessment was dropped.

• ECSC  duties  would  be incorporated  into  the  revenue structure  as  proposed by  the

Commission.

• Member  States  would continue  to  retain 10% of the  revenue  from traditional own
resources to cover the collection costs, contrary to the Commission's proposed abolition.

• A proposal for a new founh resource based on GNP was accepted. It was agreed that this
would be equal to the difference between the amount collected from VAT and traditional
ovm resources in any particular year, and the amount required to cover spending based
on the GNP  of the Member  State.  For example,  if the revenues required  to finance
spending amounted to 1.2% of EU GNP and the revenues from the first three own
resources was 1. 1 % of GNP,  each Member State would be asked to make a further
contribution equivalent to 0.1% of its GNP.

• The abatement of the British net contribution agreed at Fontainebleau was retained and
would  continue to be  borne by the Member  States  in accordance  with  their  VAT
payments. Once again, Germany's share was restricted to two-thirds of its VAT share.

12 

13 

"' 9 
.) . 

In providing the Union  with increased finance to meet its  expenditure  commitments,  the 
Brussels Agreement was a success. The actual 1988 payment appropriations represented just 
1.1 I% of GNP, 0.01% below the allowed ceiling. This gap increased in 1989 to 0.04% and 
the  financing  required  in  l 990  was 0.2%  below  that  anticipated  in  the  1988  Financial 
Perspective.  Essentially there were two  reasons - reductions in EAGGF expenditure and 
faster economic growth in the Union. This last factor also had the effect of increasing the 
VAT base and as a result the need to tap into the fourth resource was less than anticipated. 
In consequence,  the environment in which proposals were put forward in respect of own 
resources for the period after 1992 was substantially different from  that which preceded the 
Brussels Agreement. 

Edinburgh: 199 2 

3. l 0  At the  Edinburgh meeting of Heads of State and Government of 11-12 December 1992,
arrangements for own resources for the seven year period up to end-1999 were announced: 

• A budgetary ceiling increasing from 1.2% of GNP in 1992 to 1.27% in 1999 was agreed.
This was a lower ceiling than that proposed by the Commission and spanned  a seven­
year period instead of jive years.

• Intermediate annual ceilings on own resources for payment appropriations were agreed
as follows:  1.2% in 1993  and 1994, 1.21 % in 1995,  1.22% in 1996,  1.24% in 1997,
1.26% in  l 998 and 1.27% in  l 999.

• The ceiling on the VAT call-up rate was to be reduced from 1 .4% to 1. 0%, in equal steps

over the period 1995-1999.

• For Member States with a per capita GNP of less than 90% of the community average,
the assessment base for VAT payments was to be  limited to 50% of a Member State's
GNP.  This change  would  also  be  introduced  in  equal  phased  steps  over  the  period
1995-1999.

.  •' 

13 

4  Reform of the own resources system 

4.1  In this section,  we explore how the system for financing the EU might be reformed,  taking 
into account the  criticisms that  have been  articulated and  the likely consequences of the 
evolution of European integration. The latter include,  notably, the imminent adoption of 
economic and monetary union, and the prospect of enlargement. 

4.2 

In  appraising  any  particular  tax  as  an  addition  or  alternative  to  the  EU's  existing  own 
resources,  it  is  helpful  to  have  criteria  in  mind.  The  unique  political  and  institutional 
circumstances of the EU inevitably bear on the criteria to be used for this purpose. Insights 
can be derived fro_m tax theory, from the theory  of  'fiscal federalism' 4  (see box 4.1) and 
other  economic analyses.  These provide a number of what might  be termed  'economic' 
criteria, although even these need to be adapted to the circumstances of the EU. 

4.3  A second set  of  criteria  might loosely be  labelled  'administrative'.  Given the stage that 
European integration has reached ( or will by the millennium, the earliest data by which any 
changes in own resources could take effect), there are various concerns that militate for or 
against the EU tier being assig. ,cd responsibility for individual taxes.  These include reference 
to the fundamental aims set out in Article 2 of the Treaty, links to common policies and the 
implications for national tax systems of enlargement or successful attainment of EMU. 

4.4  'Polizical considerations'  are often prominent in EU policy-making and this is especially so 
on the vexed questions associated with revenue and expenditure. These are compounded 
when,  as at present,  there is reluctance by the Member States to countenance transfers of 
powers to the EU level. Equally, the EP is not alone in wishing to see greater transparency 
in  the formulation  and  implementation  of  policies.  The  fact  that  citizens  cannot  easily 
identify contributions going to the EU and the lack of direct accountability for these pre­
emptions is widely seen as a political weakness. 

4.5  No tax will possess all the desired qualities, so that the search for an optimal one is more to 
do with achieving a satisfactory mix. Were it otherwise, the search for a new own resource 
might  not  have been  so  difficult or  contentious.  The need is  to  make a choice between 
alternatives taking account both how many of these attributes each possesses and the relative 
imponance to be attached to each. In the sixth section of this Report, the criteria are used to 
assess various candidates for own resources. 

Economic criteria 

4. 6  The economic criteria judged to be important for a 'good'  Union tax reflect the principles
of  taxation,  but  have  also  been  amended  as  necessary  to  accord  with  the  particular 
circumstances of the EU. 

4.7  An important requirement is that a tax should respect equity, although the term is open to a 
number of interpretations. One of  the commonly used  principles in taxation is that a  tax 

� Annex 1 outlines the theory of fiscal federalism in more detail and discusses its relevance for the taSk 

of determining what tax.es should be assigned to the central tier and which to lower tiers. 

14 

Box 4.1 PRINCIPLES OF FISCAL FEDERALISM AS APPLIED TO THE PROBLEM OFT . .\..\: ASSIGNME!'ff 

Can anv rules be established for how ta.xes should be assigned to different levels of government in a federal
svstem'? This is one of the issues addressed by the body of tax theory which is commonly referred to as 'fiscal
f�deralism ·. In fact, :fiscal federalism is concerned not just with the issue of ta.'X assignment as between different
tiers of public administration, but more ge9erally with the provision of public goods and services.  Our concern
is essentially with the problem of how best to assign different taxes as between the federal (i.e. EU) and the state
level. 

I 

,In the literature on fiscal federalism, several different principles are identified to guide the decisions: 

I. The benefit-pricing rule.  Ta.'Xes should be assigned to different levels of government according to how the
benefits  from public  services  are geographically distributed.  If the preferences  for  a particular  public
good/service are uniform throughout the federation, it would be optimal to provide the good/service at a
federal level because the costs of providing the service per head of the population will thereby be lower. A.n
example might be external defence. However, where preferences diverge between states, the appropriate
level at which the good/service is to be provided is the state or regional level. Ta"(es should be assigned to
different levels which are sufficient to provide revenues to finance these provisions in such a way that a clear
link exists between the amount being paid by the taxpayer and the benefit received. In this way, taxpayers
can weigh up whether the value of the goods/service provided at a particular le,·el is commensurate with
the amount paid in taxes to obtain them.

2. Policy effectiveness. A further consideration emphasised in some writings on fiscal federalism is the effects
of taxation on economic policy. The pursuit of certain kinds of economic policy may more efficiently
undertaken at a federal rather than a state level yet may require the use of certain kinds of taxes for the
attainment of the policy's objectives. For example,  it may be deemed that a policy to control pollution is
better undertaken at a federal level. One reason is that neighbouring countries can otherwise 'free ride' on
pollution control measures taken by other neighbouring states. Alternatively, some states may seek to attract
investment to their territory by adopting la."(er pollution controls. Minimum environmental standards may
be needed to counteract such 'eco-dumping'. If it is decided to tackle the problem of pollution by taxing
forms of pollution such as emissions of carbon dioxide into the atmosphere. this may be more efficiently
done at the federal level.

3. The problem of tax competition. Where the tax base is relatively mobile between states. it is likely that ta.-xes
imposed at the state level will generate considerable inter-state tax competition. Taxes on labour or capital
may fall into this category. States will seek to attract mobile resources away from other states 'by lowering
tax rates resulting in a loss of fiscal revenues in neighbouring states. Alternatively, other states will follow
by cutting their ta."(es, in which cases the result could be a beggar-thy-neighbour  war. The outcome will be
a progressive lowering of tax  rates resulting in  an under-provision of public  goods  and services.  This
problem can be resolved by tax coordination between the states (e.g. the establishment of a minimum rate
of ta"() and need not require tax centralisation.

+.  Revenue arbitrariness.  A further consideration is that the revenues from certain kinds of ta.'Xes, if imposed 
at the state level, may be distributed in an arbitrary manner. One of the best examples of this is customs 
duties  imposed  by a  customs  union such as the EU.  Because a disproportionately large amount of EU 
imports pass  through  the ports of  Rotterdam  and Antwerp, revenues  from  customs  duties  are high  in 
Belgium and the Netherlands. Similar problems arise with other taxes where the incidence of the ta."( may 
fall on individuals who  reside in countries other than where the tax is levied. In such cases, there is no 
logical method of sharing out the revenues between the different states and it makes sense to assign such 
taxes to the federal tier even if the ta"( is still collected at the state level. 

15 

5. Administrative  costs.  Th� costs of collecting cenain kinds of taxes may be lower if these are levied at a
federal rather than the state level. In other cases. decentralisation is more efficient especially where account
needs to be taken oflocal needs and circumstances. Centralisation of ta"X collection may also, in some cases.
give rise to increased fraud or ta."X evasion.

A final consideration is whether or not all of a ta.'( should be assigned to one or other level of government. or 
whether taxes should be shared between different tiers. The main argument against tax sharing is the benefit­
pricing rule discussed above: where taxes are shared, the direct link between spending and taxes paid is broken. 
On the other hand, ta"{ sharing is often desirable when the revenues from a panicular ta."X vastly exceed the 
requirements of the tier at which they are imposed. A further possible advantage in tax-sharing is that, where 
revenues collected at the federal level are paid out in transfers to the state, a mechanism exists for correcting 
horizontal regional inequalities if desired. 

16 

be  related  to ability-to-pay.  Conventionally,  this is  based  on  individuals,  but  in the  EU 
context, a case can be made that it is the Member States which constitute the tax-payers, so 
that a tax should fall more heavily on the richer ones. The fact that regional cohesion is now, 
following the signing of the Treaty on Economic Union, a fundamental objective of the EU 
also argues for taxes to be related to ability-to-pay. 

4.8  The difficulty here is whether the objective should be horizontal equity - treating all Member 
States the same - or vertical equity- basing the tax on some measure of ability-to-pay. The 
principle of horizontal equity means that a regressive should probably be ruled out unless 
there are strong arguments for considering it. It is possible for an adjustment to be made to 
Member State payments of regressive taxes to bring about horizontal equity. However, this 
makes it more difficult to achieve the accountability objective discussed below. 

4.9  Nevertheless, it remains uncertain how prepared the Member States are to contemplate the 
adoption of a revenue system based on progressivity - the principle that, as income rises, a 
higher proportion of income is paid - rather than proportionality,  which implies paying in 
relation to income.  A net transfer of resources from richer to poorer regions could also be 
brought  about  by  adjustments on the expenditure side of the Budget,  as it is the balance 
between  payments and receipts that affects cohesion.  Difficulties  can,  however,  arise in 
measuring this accurately (Reichenbach, 1983). On the other hand, if regional inequities are 
resolved  through  asymmetrical  vertical  payments,  it  may  become  increasingly  hard  to 
achieve effective accountability.  Accordingly, a first criterion for assessing a proposed own 
resource is equity between Member States. 

4.10  Fairness is also an issue for individuals or groups within society. Consistent with the social 
objectives of the EU, it might also be felt that  a further requirement of any new tax is that 
it should be seen as being socially fair as between individuals within the EU and not just 
between Member States. 

4.11  Ensuring  economic efficiency is  a  third economic  criterion,  particularly because  of  the 
importance given to the single market. In terms of the EU as a whole, the kind of efficiency 
which  matters  is  allocative  efficiency,  that  is  making  sure  that  resource,s_.are  used  as 
productively as possible. If a tax regime discriminates against particuiar activities, then it 
fails to fulfil the efficiency test. 

Administrative criteria 

4.12  To be a viable own resource, any tax has to meet various administrative criteria, some of 
which have particular significance in the EU context. The criteria under this heading have, 
therefore, been selected to highlight features that a tax instrument ought to possess to achieve 
this aim. 

4.13  Good  taxes  exhibit  low  collection  costs,  that  is,  a  favourable  ratio of  yield  to  cost  of 
collection. Where there are significant economies of scale from collecting a tax at an EU­
wide level,  this  is an added  reason for assigning the tax to the EU tier. However, central 
collection and administration of the tax need not require the assignment of revenues to the 
EU tier.  In fact,  there is widespread scepticism that such cost savings from centralisation 

17 

would materialise (see Smith, 1993). Language differences and differences in legal systems 
and corporate structure mean that many taxes are likely to be more efficiently collected at 
Member State level. 

4.14  Collecting a panicular tax at an EU rather than national level involves only a modest increase 
in the scale of operation. As a!'fesult. any economies of scale would be unlikely to offset the 
costs of overcoming language and other institutional differences. Greater gains are likely to 
be  achieved through administrative co-operation between  the tax authorities in different 
Member States so as to reduce the degree of tax evasion.  Indeed, there may be a risk that 
centralisation would increase tax evasion with a consequent loss of tax revenues. 

4. 15  A second requirement is that a tax provide fiscal buoyancy, a growth in fiscal revenues over
time  in  line with  the  growth in  incomes.  For this to be  so,  revenues  must  increase as 
economic growth  takes  place without any change in the  rate of taxation.  A  weakness of 
agricultural  and  customs duties is  that the reverse has been  true.  The  former  have been 
adversely affected  by increasing agricultural self-sufficiency and CAP reform,  while the 
latter have declined as the common external tariff has been lowered. Although revenues from 
VAT have grown with increased consumption and rising prices, the VAT call-up rate may 
only be increased by unanimous agreement of the Member States. 

4 .16  Generating sufficient revenue is especially important in the EU context, because of the long­
term commitments on the expenditure side of the budget. In this respect, a revised system 
has  demonstrably  to  be  as  effective  as  the  existing  system  which  is  expected,  with  an 
economic growth forecast of2.5% a year for the EU(l5) and 4% a year for the new applicant 
countries, to create additional resources of ECU 20 billion at  1997 prices by 2006. 

4. 17  Ensuring revenue stability is also vital, given that existing rules do not allow the EU to retain
any surplus of revenues over spending or to finance any deficit in the budget by borrowing. 
Thus,  any tax whose revenues are likely to be subject to strong cyclical swings might be 
regarded as unsuitable. This might matter less if the Member States were to allow the EU to 
run a budget surplus/deficit. Although good arguments can be put forward for allowing the 
EU to play such a role as the EU moves in the direction of EMU, it would seem unlikely that 
the  Member  States  would contemplate such  a change at this stage.  For now,  it is more 
important that any new tax should provide stable revenues over the business cycle. 

4. 18  A  further  crucial  concern  in  the  EU  is  to  minimise  susceptibility  to fraud  or  evasion
Particularly in the light of recent revelations regarding the extent to which revenues have 
been lost through fraud,  it is essential that the assignment of any tax to the EU does not 
increase such a susceptibility. 

Political criteria 

4. 19  It is no exaggeration to say that whatever the apparent merits of a prospective own resource
on analytic criteria, it must be not offend Member State sensitivities. For all sorts of reasons, 
certain  taxes may face particular political problems that render them  unsuitable.  This is 
inescapably linked to the political and inter-institutional balances of power in the EU. Strong 
opposition, for example, could be anticipated from Member States to any suggestion that 

18 

income taxes be re-assigned to the EU level. Concerns about competitiveness militate against 
payroll taxes, notwithstanding the fact that a re-assignment would allow other taxes to be cut. 
Similarly, Member States regard  excise duties on tobacco and  alcohol as social policy as 
much as fiscal. Disparate political factors may well be central to the choice of own resources. 

4.20  To avoid undue opposition,�y new tax should possess a harmonised tax base. Even if this 
is  not currently in existence,  it should  be the  case  that agreement is  attainable from the 
Member States on the creation of such a base. As is argued below, one of the attractions of 
VAT as  an own resource is that such a base exists although the actual base on which it is 
levied  not been identical in  all Member States. It remains uncertain whether it will prove 
possible  in  the  future  for  the  Member  States  to  agree  to  the implementation  of a  fully 
harmonised base. By contrast, no such base exists for direct taxes such as personal income 
tax nor is there much prospect of the Member States reaching such an agreement. In the case 
of Corporation  Tax,  however,  progress  has  been  made,  albeit  slowly,  in  recent years in 
reaching agreement on the base, and it is conceivable that implementation of the  1997 Action 
Plan for the Single Market will speed-up this process. 

4.21  Any  new tax  should  aim to enhance the democratic accountability of EU spending. The 
Council is the ultimate authority for revenue raising and the EP has only a consultative role 
in agreeing own  resources.  Moreover,  the responsibility for  collection lies with Member 
States. This is linked to the visibility of own resources.  If a visible link can be established 
between  what  the  individual citizen  is  paying  in taxes  to  the  EU  and the  benefits which 
citizens  enjoy  from what is spent by the EU,  this will make EU activity transparent5
.  The 
current own resources do not score well in this respect. As discussed elsewhere in this report, 
the problems are exemplified  by  the absence of a  visible  link  between  VAT  paid when 
buying goods or services and the level of EU spending. There are several reasons for this: 

• VAT revenues are shared between the Member States and the EU.

• The individual taxpayer is unaware what part of any VAT paid goes to the EU.

• The actual base used to collect VAT in the Member States differs from the harmonised

base on which VAT is levied by the EU.

• Differences  between  EU  spending and the amount collected in VAT and other own

resources is met out of GNP-based contributions from the Member States.

4.22  The acceptability of an EU tax would be enhanced if it is seen to have links to common 
policies or objectives of the EU. These are the economic, social and political objectives set 
out in the European Treaties which the various common policies of the Union seek to realise. 
For example, the imposition of levies on fann products in structural surplus has at times been 
regarded as being a necessary instrument for achieving the policy objectives of the CAP. The 

5 Among the expens we consulted, several saw this as two-edged.  On the one hand, it could highlight 
the role of the EU in increasing the overall burden of tax.ation and lead to hostility towards EU activities. 
On the other hand, making the public aware of the relatively modest scale of the EU budget may help to 
scotch ill-founded stories about the over-bearing role of 'Brussels'. 

19 

recent  proposal of the Commission for an EU carbon  tax to reduce  gas emissions which 
contribute  to  global  warning  may  help  achieve  the  objectives  of  the  EU' s  common 
environmental policy. If such taxes meet other criteria for imposition at the EU level, these 
considerations may strengthen the case for adopting them as additions to EU own resources. 

4.23  Subsidiarity  is also an iss�.  Although the principle of subsidiarity is that  policy  actions 
(including taxation) should be carried out by the lowest competent tier of government, the 
principle equally implies that, where appropriate, the supranational should be responsible. 
The case for assigning particular taxes to the EU tier rests on the existence of ' externalities' 
or 'spillover effects'  from levying taxes at the national level. Any national tax which gives 
rise to such effects would constitute a good candidate for  being  assigned to the EU tier. 
Many environmental or energy taxes possess these properties. At the same time, arbitrariness 
in the regional allocation of fiscal revenues is a property which  would make a tax suitable 
for assignment to the central level. 

4.24  We have already observed that this problem is typical of the agricultural and customs duties 
collected  by  the  Member  States. The Rotterdam-Antwerp effect illustrates this well.  The 
same is true of the revenues which are generated by the taxation of corporate income within 
the EU.  These characteristics will not necessarily make the taxes in question suitable for 
adoption  as  new own resources,  as  they  may fail to  meet  the  other  objectives  sought. 
However,  it  does  mean that,  other considerations to one side,  they  constitute  taxes  which 
may be more efficiently levied at an EU-wide level. 

20 

5 

Options for Reform 

5. 1 

In  this  section  of  the  Report,  we examine  eight  options  for the  creation  of a  new own
resource. These are: 
• A surcharge on income tax
• A European withholding tax
• A European corporation tax
• Modulated value added tax
•
Environmental/energy tax
• Alcohol and tobacco excises
• Using seigniorage revenues
• New communications taxes

5.2 

In each case,  we consider the merits and demerits  of each in terms of the criteria set out 
above.  However,  a  key  requirement  will  be  political  acceptability  and  some  of  these 
alternatives may have to be excluded because of the unwillingness of the Member States to 
surrender sovereignty in these areas. 

Income Tax 

5 .3 

Income tax is one of the most widely used of revenue-raising instruments, accounting for an 
average of around 25% of tax receipts in the EU in 1994 (OECD, 1996). In most federations, 
personal income tax is either assigned exclusively to the central tier (for example, Australia 
and Canada), although in some cases revenues may still be  shared with the states, or the tax 
is  imposed  at  both  levels.  An  important  exception  is  Switzerland  where  income  tax is 
imposed at the cantonal/municipal level only. 

What is it? 

5.4  The most  likely form which this could take if applied in the EU would be a surcharge on 
personal income tax levied by individual Member States. A more elaborate (and progressive) 
proposal,  discussed below,  is that each Member  State would be required to make annual 
payments to the EU based  on its share of EU GNP,  adjusted by the ratio of its  per capita 
income relative to the EU average. A percentage surcharge would then be imposed by each 
Member State on levels of personal income tax sufficient to raise the revenues required. 

Principal attractions as a  'European · tax 

5 .5  The  assignment of income tax to the central tier is supported by some of the writings on 
fiscal federalism ( e.g. Musgrave,  1983 ).  One reason is that  income taxes often perform a 
redistributive function. If income taxes are imposed at the regional level, they may give rise 
to undesirable migration effects. For example, suppose there are two countries, A and B. A 
adopts a highly progressive system of income tax because it wishes to bring about a more 
egalitarian distribution of income. B favours a less even distribution of income and hence 
adopts a proportional system. If there is high labour mobility between the two countries, high 
income earners in A will migrate to B while high-income people favouring distribution and 

21 

low  income  earners  in  B  will  migrate  to  A.  A  will  thus  be  unable  to  achieve  much 
redistribution because most low-income people will move to this country. This could only 
be avoided if labour mobility were somehow prevented. 

5.6  Others  have  questioned  the  relevance  of these  considerations  for  the  EU  where  labour 
mobility is much lower (e.g. Spahn, 1993). In general, tax theory argues that taxes which are 
levied  on  highly  mobile  tax  bases  are  better  assigned  to  the  central  tier  because  tax 
competition between states would otherwise reduce tax revenues to a level inadequate for the 
optimum provision of public goods.  These problem can, however, be resolved by Member 
States agreeing to apply a minimum level of tax. Alternatively, a uniform rate of tax could 
be applied but this need not necessitate centralisation of the revenues from such a tax. 

5. 7  Because income tax in most countries is, to varying degrees, progressive, a European income
tax would also result in income redistribution between the Member States. Richer Member 
States would make larger payments than poorer Member States. Arguably, this is a simpler 
way of ensuring fairness on the revenue side of the budget than applying a 'progressive key' 
to VAT contributions (as proposed by the McDougall Report) or capping VAT payments of 
Member  States with .below-average per capita incom�s as at present. 

5. 8 

Income tax could generate sizeable revenues which would also increase proportionately with
income.  In other  words,  the tax would  exhibit fiscal buoyancy. With an unchanged rate, 
revenues would increase in line with economic growth. From the perspective of cohesion, 
a particular attraction of such a tax is that it contains a built-in incentive for richer Member 
States to encourage regional convergence within the EU. The more quickly weak countries 
can catch up with strong countries in levels of per capita income, the lower the fiscal burden 
on strong countries. 

5.9  Finally,  the tax would have the attraction of being highly visible, especially if the amount 
of the tax going to the EU was explicitly stated on the tax declaration of every taxpayer. This 
would serve to enhance the objective of accountability as the taxpayer would be able to relate 
the tax paid to the EU to the benefits those taxes bring. 

Disadvantages 

5 .10  There are potentially difficult obstacles to the use of income tax as an own resource. While 
tax  theory  favours  assigning  taxes  with  highly  mobile  bases  to  the  highest  tier  of 
government,  it also attaches a high degree of importance  to decentralisation to cater for 
divergent preferences at lower levels of government. In the EU, the Member States retain 
often very different views about the best way of taxing income. This includes the question 
of how redistributive the income tax system should be. 

5.11  Social policy matters (for example, how to treat earned versus unearned income, how to treat 
the  income of married versus single people, whether or not the incomes of poor income­
earners should be increased through the tax or benefit system, etc) also come into play. These 
considerations argue strongly against any attempt to tax incomes at the EU level. 

22 

5. 12  A major problem is the absence of a hannonised tax base. This means that any attempt to tax 
incomes  at  the European  wide level  would  give rise  to  serious  inequities.  It  is  highly 
improbable  that  at  any  stage  in  the  future  the  Member  States  would  be  able  to  reach 
agreement on how the tax base could be established on a harmonised basis for the reasons 
aiven above. Spahn (I 993)  illustrates the argument by comparing Gennany which has a 
broad income tax base with France which has a relatively narrow tax base.  Thus, the same 
payment to the EU would require a much higher level of taxes in France than in Germany. 
This would be viewed by French taxpayers as unfair and simply alienate French taxpayers 
from the Union. 

5 .13  Sensitivities  about national sovereignty mean that income tax is one which the  Member 
States are unlikely easily to relinquish. This is bound up with choices regarding the balance 
between direct and indirect taxes and views on the desired level of income redistribution. 
Member States also differ on the effects of high tax rates on incentives. 

5.14  Under EMU, the Member States will continue to have autonomy over fiscal policy, subject 
to the restrictions in the Stability Pact. It can be argued that power to set direct taxes needs 
to be retained to pursue national stabilisation policies to counter asymmetric shocks to their 
economies.  The Commission's Action Plan for the Single Market proposes measures for 
increased harmonisation of taxes and certain corporate taxes. This will not be possible unless 
the Member States preserve the freedom to detennine their own levels of income tax. 

How might it work? 

5. 15  Various proposals have been put forward for some kind of progressive European Income Tax
(See El-Agraa and Majocci,  1983; Biehl, 1985: Biehl,  1990; Biehl,  1992; El-Agraa,  1994). 
Biehl proposed a two-stage procedure for deriving a progressive surcharge on income (plus 
corporation) tax as follows: 

• In the first stage,  each Member State would be assessed on the basis of its per capita
income  to  detennine  the amount to be paid.  This first stage is thus tantamount to a
system of progressive national contributions.

• In the second stage, the overall tax burden of each Member State is transformed into a
uniform  percentage  surcharge  on  national  tax  payments.  The  surcharge  would  be
explicitly shown on each tax declaration (and each national tax invoice) so that each
taxpayer would know the payment to finance EU expenditure.

5 .16  In stage one, it would be necessary to decide the degree of progressivity which is desirable. 
Biehl ill�strated how this  might work using a 'progressivity ratio'  of 1:10 so  that,  for a 
country with an above-average per capita income, its payment would increase by one-tenth 
for each one per cent deviation from the EU average. A further possibility might be that such 
a tax be used to finance half of all EU expenditure (a half-financing model), the rest coming 
from traditional own resources plus VAT. 

5 .17  El-Agraa and Majocci ( 1983) proposed a similar model. It was assumed that one-half of all 
EU expenditures  would  be financed by a  progressive  income tax. (El-Agraa assumed  a 

23 

budget equal to 2.5% of GDP i.e. as was proposed in the McDougall Report). To illustrate 
this. we have reworked the model for EU( 15) assuming a budget equal to 1.27% of GNP as 
proposed in the Commission's Agenda 2000. Using this progressive approach, the tax would 
vary  between a low of 0.47% of GNP in Portugal to a high 2.07% for Luxembourg. For 
some, this may be too great a degree of progressivity for comfort. 

A European Withholding Tax 

What is it? 

5 .18  Withholding taxes are taxes which countries impose on  the  dividend  and interest income 
derived by investors from the activities of companies located in their country. In some cases, 
these  may  be  imposed  on foreign investors  only,  in  other cases  both  local and foreign 
investors  are  subject  to the  tax.  Some  countries  impose  withholding  taxes  on  dividend 
income only, others on both interest and dividend income. 

5.19  These taxes serve two purposes: ensuring compliance with tax obligations by preventing tax 
evasion; and, for cross-border payments, ensuring that the country gets a share of the incJme 
derived  from  profitable  activities  which  have  taken  place  within  its  borders.  One 
consequence is that, in effect, dividend income gets taxed twice. However, because interest 
payments on corporate debt are usually deductible from company profits in the assessment 
of corporation tax,  the withholding tax enables the source country to tax payments which 
would otherwise not be subject to tax. 

5.20  A  common  withholding  tax  on  interest  income  from  savings  was  proposed  by  the 
Commission in 1989. The proposal was to withhold a minimum of 15% of the interest paid 
to EU residents on savings placed in another Member State. One of the reasons for the tax 
was to prevent foreigners from taking their money out of the EU through countries such as 
Luxembourg where no tax was deducted at source following the removal of intra-EU capital 
controls.  The  proposals,  however,  were  bitterly contested  by  the UK  and Luxembourg. 
Luxembourg was the only Member State where no withholding tax was imposed on either 
bond interest or bank/savings interest, while the UK imposed withholding tax on the interest 
income of non-residents only. 

Principal attractions as a  'European · tar 

5 .21  Economic efficiency arguments favour a common system for taxing this form of capital 
income.  Large differences in  both tax rules  and  rates  of tax imposed  on  interest income 
within the EU are widely regarded as distorting the allocation of portfolio investment within 
the EU. They also create opportunities for tax competition between the Member States in an 
effort to attract new investment to their territory. We have already seen that the principles 
of fiscal federalism favour centralising at the federal level taxes on highly mobile tax bases 
such as portfolio investment. 

5 .22  The high inter-state mobility of savings means that. given large differences in rates of tax 
within the EU, tax authorities in different Member States must cooperate closely to prevent 
tax evasion. The establishment of a common withholding tax would facilitate this for EU 

24 

residents. An additional advantage of the tax is that it may be seen as being linked to the 
Union's commitment to liberalising movements of capital within the EU i.e. to a specific 
common policy objective. 

Disadvantages 

5.23  The  main  objection  to  proposals  for  a withholding tax  was  that  it  would  put  European 
financial centres  at  a  disadvantage  in attracting portfolio capital from abroad as  well as 
encouraging European investors to place their savings elsewhere. For example, funds placed 
with banks in Switzerland would not be subject to tax. Other drawbacks are that: 

• the tax might also have an undesirable effect on the supply of resources within the EU
and hence on long-run economic growth. Specifically, it would result in higher pre-tax
rates of interest which could, by raising the cost of capital, deter capital investment.

• unless  set  at  quite  high rates,  the  revenues from  withholding  tax  are  unlikely  to  be
sufficient to meet the  future financial needs of  the  EU.  If  the introduction of  such a
measure were to lead to non-residents repatriating their capital or shifting funds to a tax
haven outside the EU, the tax could even be degressive, with revenues falling over time.

• because  of fluctuations in interest rates  and  dividends,  the tax  would  not generate a
sufficiently stable source of revenue as yields would fluctuate greatly from year to year.

How might it work? 

5.24  The simplest approach  would be  to adopt the original proposals of the Commission put 
forward in February,  1989. These envisaged a 15% levy on bond interest and bank/saving 
interest on all tax residents of the Union. This would cover not only EU residents living in 
one Member State but placing their funds in another, but also anyone (EU or third-country 
alike) resident in the EU for tax purposes. (Dividend income was exempt on the grounds that 
this was already covered in most Member States by the 'imputation system'  whereby tax 
paid  on  dividends  could  be counted as  a  credit against the  annual tax  liabilities  of  the 
shareholder).  The Commission's proposals also excluded tax  on Eurobonckfor fear this 
would drive international capital markets  out of the EU altogether.  The  15% rate which 
involved some slight increase in the EU' s existing tax level on saving income was considered 
low enough not to encourage a large-scale exodus of capital from the EU. 

A European Corporation Tax 

What is it? 

5 .25  The possibility that company taxes might provide a new basis for Union resources has been 
considered in several discussions of the own resources problem (e.g. the Spinelli Report, the 
European Commission's  1978  Way Ahead discussion paper, the Colom I Naval Report of 
1990).  Indeed,  in most federal  systems  of the  world,  company taxes  are either  shared 
between the federal and state levels or the two levels impose competing taxes. In Australia, 
company taxes are levied exclusively at the federal level but with revenues shared between 

25 

the federal administration and  the states.  Canada  the USA and Switzerland all operate a 
system of competing company taxes, while in Germany the tax is shared between the Federal 
administration and the Lander. 

5.26  Broadly speaking, two different systems currently operate within the EU for taxing company 
profits.  At  one  extreme,  certain  Member  States  treat corporate income separately  from 
personal incomes (the so-called Classical or Separate  Tax System). This means that profits 
which are distributed in dividends to shareholders are taxed first as company income and 
then separately as shareholders'  personal income. Since distributed profits are effectively 
double-taxed, this creates an incentive for companies to reinvest profits in the company. 

5.27  At the other extreme,  there are Member States which allow shareholders full or partial tax 
credits  against  personal  income  tax  liability  for the  tax  which  can  be  imputed  to  the 
dividends received (the so-called Imputation or Tax Credit System).  In effect, the dividend 
of the shareholder is grossed-up by the amount of the tax on undistributed profits which is 
imputed. All of the largest Member States (France, Germany, Italy and the UK) operate this 
system.  Certain  other Member States (Spain  and Portugal) operate very similar systems. 
Finally, there are a few Member States which operate a so-called Split-Rate System whereby 
shareholders'  pay  a  special flat-rate personal  tax  on  dividend income  which  indirectly 
provides them with an element of tax relief 

5.28  Despite numerous attempts to harmonise company taxation (e.g. the Neumark Committee 
of 1963, the Van den Tempel Repon of 1977, the Commission's own proposals of 197 5 and 
1990 and the Ruding Repon of 1992), large differences remain. A case can, nevertheless, be 
made for the adoption of a European Corporation Tax to apply throughout the Union. Below, 
we consider options for how this might work. 

Principal attractions as a  'European · tax 

5.29  There are three reasons why Corporation Tax is a good candidate for assignment to the EU 
tier. The first is  that national  systems  of taxing company profits distribute the resultant 
revenues in an arbitrary manner as between different tax authorities. This is because the 
incidence of Corporation Tax is never wholly borne by the company on whom the tax  is 
imposed. Pan of the tax gets passed on both to consumers in the form of higher prices and, 
possibly, workers in lower wages. If these consumers and workers reside in a country other 
than the one imposing the tax, the revenues from the tax will accrue to a tax authority in a 
country different from the one where the tax is in effect being paid. 

5.30  In the same way,  if some shareholders are residents of a country other than the one where 
the  company  is  being  taxed,  the tax is  paid  by citizens  of another  country.  Only  if the 
company produced and sold all  its  goods  in  one  coumry and if the company was wholly 
owned by shareholders who lived in that country will the tax, in effect,  be paid by citizens 
belonging to that country. This need not imply that it is 'right' that the revenues raised by 
the tax should go to the country where the tax is borne. It is simply to state that the actual 
allocation of revenues from the imposition of national taxation of company profits has little 
if any logic. Moreover, the fact that national taxes on company profits are, to some degree, 

26 

paid for by the citizens of another country weakens the claims of individual countries to the 
· right'  to impose their own company taxes.

5.31  The administration of company taxes is more problematic at the national level when many 
companies have sizeable operations in other countries. The reason is the ease with which 
multinational companies can shift profits across borders. They can do so in two ways: 

• Through the manipulation of transfer prices on intra-firm sales from the parent company
to the affiliate or on intra-firm purchases by affiliates from  the  parent  company.  For
example, the parent company could over-invoice sales of goods or services to affiliates
in order to shift profits from a high-tax to a low-tax country.

• Through so-called thin capitalisation, whereby a company decides to finance an overseas
operation through the issue of debt rather than equity in order to shift tax liability from
a high-tax to a low-tax: country.

5.32  Most  countries  have  developed  complex  rules  to  control  such  practices.  For  example, 
transfer-price manipulation may be overcome by applying the equivalent anns-length price 
to intra-firm trade if the information exists to determine this. An alternative is for the tax 
authorities  to allocate global  profits to the different  parts of the multinational company 
according to some objective criteria. However,  for companies operating  on  an EU-wide 
basis,  these problems could be overcome if profits were taxed at the EU rather than the 
Member State level. 

5.33  Another argument for assigning Corporation Tax to the EU tier is that, where Member States 
operate different systems of Corporation Tax and impose different rates, economic efficiency 
is distorted. Different tax: rates are likely to result in a misallocation of resources within the 
EU giving rise to a measurable efficiency loss. The nature of the  distortion will depend on 
the method used to tax company profits.  At the same time, in a Single Market where capital 
can  be  invested  without restriction,  intra-state  tax  competition  is  likely  to  result.  The 
theoretical possibility exists that such competition could lead to company tax rates being 
reduced to zero,  thereby  undermining the ability of the government to  achieve adequate 
provision of public goods and services. This is discussed further in Box 5. 1 which shows 
how different approaches to company taxation distort efficiency. 

5.34  A European-wide Corporation Tax has the attraction that it would raise substantial revenues, 
more than sufficient to meet existing spending commitments.  The Colom I Naval Report 
(EP, 1990) estimated that, if 64% of the yield from company tax was assigned to the EU 
(roughly the amount accruing to the highest tier in federal states in the OECD), this would 
add ECU 65 billion to the EU's revenues (at 1988 prices) nearly double existing resources. 

Disadvantages 

5 .3 5  The biggest problem with a European Corporation Tax is the lack of a harmonised base. As 
we have seen, major differences still exist between the Member States on the way in which 
corporation  tax  is  levied.  These,  in  tum,  reflect  philosophical  differences  about  how 
corporate income should be treated. Among other drawbacks are that: 

27 

Box  5.1  How DIFFERENT SYSTEMS OF  COMPANY TAXATION DISTORT ECONOMIC EFFICIENCY 

The theoretical literature distinguishes between two effects on economic efficiency where rates of corporation 
tax differ:-

a. The first arises from the application of the Source Principle whereby the profits of a company are ta."-ed by
the country where production and sale takes place. If profits are taxed at source, investment will be attracted
to the country with the lowest corporate tax. This will lead to tax competition in which each country engages
in  beggar-thy-neighbour  policies  in  an  attempt  to  attract  footloose  capital  to  its  own  territory.  By
undercutting other Member States, each country would seek to attract sufficient additional capital such that
the tax base on which the lower rate is levied would expand sufficiently to offset the fall in the rate. If the
supply of capital were sufficiently elastic, fiscal revenues from ta.x on foreign companies would increase.
However, this will fail if other Member States follow suite by cutting their rates. In theory, if capital were
perfectly mobile, tax competition of this kind could lead to the rate of corporation tax falling to zero. In
practice. this is unlikely because decisions about where to invest are decided by many factors, not just ta.x
differences.

A further consideration is that, if the tax levied in the foreign country is lower than in the home country, 
many countries require companies to pay additional tax on prnfits repatriated to the parent company. If this 
were universally applied, a reduction in the tax rate in any one country would be only partially successful 
in attracting new investment. Instead, the home country would simply acquire additional tax revenues at the 
expense of the foreign tax-cutting country. Finally, we should bear in mind that what counts is the effective 
not nominal rate of company tax. A higher rate may be offset by more generous allowances for depreciation, 
etc against profits. 

b. The  only way of eliminating the  kind  of distortion discussed above  would be  to  apply the Residence
Principle under which companies would be taxed at the rate applying in the country where they are resident
not where they produce.  Such a tax would be referred to as 'capital export neutral'(CEN). Unfortunately,
however, the allocation of capital would still be distorted within the EU for a different reason. Certain kinds
of goods cannot be produced in one country  and then sold to another. Rather production must take place
in the country where the good or service is sold. For example, if a Spanish company wins a contract to build
a bridge in Greece, there is no alternative to building the bridge in Greece! Application of the Residence
Principle is therefore not sufficient to avoid any distortion in the allocation of capital in the EU. If the bridge
could have been built more cheaply by a German contractor, yet the Spanish contractor is able to bid at a
lower price on account of facing a lower rate of tax., the contract will be awarded to the Spanish company
and resources will be misallocated within the EU. In this case. the distortion could only be removed by an
application of the Source Principle.  Such a tax would be referred as to as 'capital import neutral'  (CIN).

It is clear that these two requirements pull in opposite directions. The attainment of CIN· favours application 
of the Source Principle, whereas CEN would require enforcement of the Residence Principle. Devereux. and 
Pearson (1990) have  argued that inefficiencies resulting from the absence of CEN are probably greater than 
those arising from the absence ofCIN. This is because differences in the costs of producing a good in different 
locations \\-ithin the EU are probably greater than differences between companies with different nationalities 
selling goods or services in the same area. This would favour a shift towards the Residence Principle as the 
preferred method for coordinating company taxes in the EU. 

On the other hand,  because the Member States are currently operating a system closer to the Source Principle, 
it would be  politically easier to achieve CIN than CEN.  A  further problem is that the application of the 
Residence Principle may necessitate a redistribution of profits between the Member States. This is because 
taxes ·which preYiously went to the source country now go the country where the parent company resides. This, 

28 

however, could be resolved by continuing to tax profits at source, while the resident country grants taxpayers 
full credit for all taxes paid abroad. The problem is that this  would lead to one undesirable side-effect: any 
increase in the ta-x rate in the source country would have the  effect of reducing the tax received by the residence 
countrV. There would, therefore, need to be a clearing mechanism similar to that proposed by the Commission 
in  198-7 for VAT following the change from the destination to the origin approach. 

! 

.

29 

• because the taxation of company profits is,  in some Member States, integrated with the
taxation of personal incomes, it is unlikely that the Member States will be  prepared to
cede to the  EU the right to control  levels of corporation tax.  Political considerations,
therefore,  weaken the case for this tax as an own resource.

• although such a tax would raise substantial revenues, this would be subject to sizeable
cyclical fluctuations,  falling in recession years and rising in boom periods. This could
make the tax unsuitable as one on which the Union relies for a major part of its revenue
needs.

• Corporation Tax scores badly in establishing in the eyes of the individual taxpayer a
visible link between  EU revenues and spending. Although it could be made visible to the
company, the incidence of the tax would be borne in part by consumers in a way which
would be uneven and disguised. The visibility criterion would, consequently,  not be met.

How might it work? 

5.36  It would still be possible for a  European-wide Corporation Tax to be administered at the 
Member State level although a prerequisite would be that the Member States used the same 
definition of tax.ab le income and the same set of tax rules. Having the same  tax rates in all 
the Member States would overcome the problem of inter-state tax competition. 

5.37  Alternatively, a uniform Corporation Tax could be administered at an  EU-wide level. Since 
revenues from all Corporate Tax.es account for roughly 6% of GNP in the Member States, 
revenues would be shared between the Member States and the EU. Barely one-sixth of the 
proceeds of these tax.es would be needed to finance the  EU. In the decentralised model, the 
revenues would initially accrue to the Member States, a portion of which would then be 
assigned to the  EU.  In the centralised model, the reverse would be true:  the revenues would 
initially  accrue  to  the  EU,  but would  then  be  disbursed  in  part  to  the  Member  States 
according to an agreed formula. 

Modulated Value Added Tax 

5.38  As discussed above, VAT is already the core of the current system of own resources. If only 
because of inertia, it is, consequently, an option that cannot be ignored. However, the fact 
that the VAT resource has been subject to criticism argues for a fresh look at how it is used 
as an own resource. 

What is it? 

5.39  The preferred option of the Budgets Committee of the  European Parliament is to replace the 
existing third and fourth resources with a new third own resource in the form of a proportion 
ofVAT(EP,  1994). The  1994LangesReponstated that: 

30 

Box 5.2  THE HAR:\-IONISATION OF VALUE-ADDED TAX WITHJl'i THE EU 

The svstem operated by the EU since a common system of VAT was introduced is based on the destination
principle whereby goods are taxed at the rate of VAT applying in the country where the goods are ultimately 
consumed. This means that exports are zero-rated. while imports are subject to VAT at the rate applying in the
importing country. Before  1st January, 1993. these adjustments were made whenever goods crossed borders
between the Member States. However, with the arrival of the Single Market, frontier posts disappeared. This
necessitated changes in the way in which VAT was collected.

In 1985. the Commission's White Paper Completing the Internal Market identified fiscal barriers created for 
the purp�ses of making tax adjustments on goods traded between Member States as a major impediment to the 
realisation of the Single Market. The White Paper proposed that these should be removed by: 

a.
b 

c.

substituting the destination for the origin principle
introducing a  Clearing Mechanism to ensure that VAT revenues go to the consuming and not the
producing country 
by approximating national VAT rates.

Under the  origin principle, VAT is imposed on goods at the rate applying in the country of production not 
consumption. The origin principle obviates the need to stop goods at the border for the purposes of collecting 
VAT.  Instead, goods which are exported from one Member State to another enter the importing country 
carrying the VAT imposed by the exporting country. Importers are then able to claim the VAT already paid on 
the goods as a credit against the ta""< due on goods sold. If the VAT rate was higher in the exporting than the 
importing country, the importer could receive a refund. 

However, since a switch from the destination to the origin principle would transfer revenues from Member 
States which were net importers of goods subject to VAT to Member States which were net exporters. the 
Commission proposed a Clearing Mechanism to ensure that no Member State suffered a loss of fiscal revenues 
as a result of the change . 

.In  1987, the Commission published a more detailed set of proposals for achieving these objectives.  These 
contained provisions for harmonising VAT rates within two bands: a standard rate to vary between 14-20% and 
a reduced rate to vary between 4-9%. The Commission based these bands on the experience of the United States 
where differences in rates of sales ta""< of this order were found to be workable. The concern of the Commission 
:was that, with the abolition of border posts, consumers would enjoy unfettered freedom to cross borders and 
; buy goods from the Member State with the lowest VAT rates. 

Nevertheless, there was strong resistance from certain Member States to the restrictions which this placed on 
their freedom to determine their own rates of VAT.  Member States with relatively high rates of VAT (e.g. 
Denmark and Ireland) were concerned about a loss of fiscal revenues, while Member States with relatively low 
VAT rates- (e.g.  Luxembourg) were concerned that prices would rise. Other countries (e.g. the UK) which 
currently applied a zero rate of VAT on certain necessities were strongly opposed to the requirement that such 
goods should be subject to the proposed reduced rate. 

The proposed Clearing Mechanism was to entail the establishment of a central account denominated in EUUs 
un�er the responsibility of the Commission into which net exporting countries would make payments and from 
which net importing countries would receive payments on a monthly basis. Each month, Member States would 
be required to determine the balance of  their VAT based on their intra-EC exports and imports i.e. VAT 

31 

collected on exports less VAT owed on impons. They would do so by collecting from traders infonnation 
regarding VAT claimed on impons from other Member States and VAT paid on expons to other Member States. 

These measures aimed to abolish fiscal frontiers while at the same time allowing Member States to enjoy some 
flexibility in detennining the rates of VAT which they wished to apply. The aspect, however, which attracted 
the  most criticism  was the proposed Clearing Mechanism for redistributing Ievenues from VAT.  The main 
weakness was seen to be the element of 'enforcement asymmetry' which they contained. There was little or no 
incentive for Member States to check that VAT claims made by importers were true since the Member State 
would anyhow be reimbursed for  the cost of such claims. The proposals of the Commission were therefore 
rejected. 

In May 1990, the Commission put forward a new set of proposals in an attempt to secure a compromise before 
internal frontiers were due to disappear altogether. This allows the Member States to temporarily continue 
applying the destination principle collecting VAT in the countries where goods are consumed not produced. 
Exports  would  continue to be zero-rated but instead of taxes being collected on impons when they cross 
borders, reliance  would  be placed  on  administrative controls.  When making  their  quarterly VAT returns, 
importers would be required to  declare any VAT due on  goods imported from another Member State.  To 
pre\'ent fraud, cooperation between tax officials in different Member States would be increased. By the end of 
1996, however, a systerr, based on the origin principle would be introduced. 

In June  I 991, it was agreed that. from  1993 onwards. a minimum rate of  15% on VAT would be charged 
throughout the EU to prevent tax competition  from lowering the VAT rate.  There were special provisions 
allowing certain goods to be subject to a reduced rate of 5%, while Britain, Ireland and Portugal were allowed 
to keep their zero-rating of sensitive items such as food. In a last minute compromise to placate the British, it 
was agreed that the 15% minimum would have legal force for four years only and that unanimity would be 
required before it could be reimposed. 

In its recent Action Programme for the Single Market (CEC, 1997), the Commission calls for the adoption of 
a plan to achie\'e a common system of VAT based on the origin principle. It envisages three sets of measures 
which reaffinn the aim of establishing a single market with minimal ta."X distortions: 

a.

A package of measures to define taxable operations, VAT liable operators, the taxable base, attitudes
to  exemptions, and conditions under  which tax deductibility can be  conferred,  followed by new
proposals for approximation of rates

b. Another set of measures to pave the way for the elimination of the destination principle.

c. The creation of mechanisms for reallocating VAT revenues between Member States and for the final

approximation of rates.

32 

· A  proportion  of  a  largely  harmonised  VAT,  imposed  on  the  basis  of  tax
declarations and clearly denoted on each individual invoice as EU taxation, would
at present be the most convincing form of own revenue' (EP, 1994, page 16)

5.40 For VAT to achieve these objectives it would, however, have to raise a higher proportion of 
EU revenues than at presc;;nt. A key part of the proposal was the suggestion that the VAT 
imposed on consumers by  the  Member  States should  be  divided up into a EU part and a 
national part and that each part should be determined separately. The Commission  and the 
Parliament would determine the EU part  and national parliaments the second part. Thus, 
although VAT revenues would continue to be shared as at present, the amounts collected by 
the two tiers would be independently determined and would be distinguishable in the eyes 
of the EU citizen. A figure of 2% was suggested as a starting point but the figure could then 
be increased if the commitments of the EU were extended. To establish social fairness, the 
Report further proposed  that the VAT rate should be split, with  a lower rate of  1.5% for 
basic necessities and a higher 3% rate for all other goods and services. 

Principal attractions as a  'European ' tax 

5 .41  Adopting  VAT  as  a  new  third own  resource  in  place  of the  existing  third  and  fourth 
resources has several advantages. VAT is a buoyant source of revenue as tax receipts grow 
in line with increased spending on goods and services without any change in the VAT rate. 
Moreover, if resources need to be increased, this is achievable through an increase in the 
VAT rate, although currently this is dependent on the willingness of the Member States to 
agree. 

5.42  A far  from  negligible  attribute  of VAT  is  its familiarity to  the  taxpayer.  There may  be 
advantages in making better use of this tried and tested method for collecting EU  revenues 
rather  than  experimenting  with new  ones.  Moreover,  the  EU  already  has  a  reasonably 
harmonised tax base for VAT, although the actual bases applied by the Member States still 
differ in several respects. For example, the UK imposes. no VAT on food or newspapers. 
Nevertheless, in its Action Programme for the Single Market (CEC, 1997), the Commission 
has  proposed  that  further  measures  be  adopted  to  achieve  a  common  system  of VAT
throughout the Union (see Box 5.2) 

·  , 

5 .43  VAT can be collected directly via tax declarations,  so that there would be no  additional 
administration  costs  in  adapting  the  present  system  to  one  based  on  a  two-tier  rate  as 
proposed by the Parliament. 

5 .44  Finally, VAT  remains possibly the best way of establishing a clear link in the minds of 
citizens between what they pay in EU taxes and the costs of the EU. This would be enhanced 
if the VAT rate paid by consumers was separated into an EU and a Member State part on the 
bills received by consumers. 

Disadvantages 

5 .45 A concern  about VAT  is that it is a regressive form of tax  both at the  individual level
(because lower income households tend to devote a higher proportion of their income to

·

33 

consumption)  and  as  between  Member  States.  Nevin  (1988)  compared  the  actual  VAT 
payments of Member States with the payments they would have made if contributions had 
been based on ability to pay. He found that, during the years  1980-4,  a number of Member 
States - Gennany, France, Ireland and the UK-were all paying more than would be expected 
on the basis of income. Others - Belgium, Denmark, Italy and the Netherlands - underpaid. 
When expressed on a ECUper capita basis, however, the over/under-payment was not very 
great. In no country did it exceed 7% of the amount paid. 

5.46  We have reworked Nevin's calculations for a more recent period. The results in Tables 5.1 
and 5 .2 show the extent of over-funder-payment of VAT comparing actual  VAT payments 
with  the  outcome  to  be  expected  if VAT  payments  had  been  related  to  ability  to  pay. 
Interestingly, we found that  the reverse was true.  During this period,  the UK along with 
Ponugal,  Greece and Italy paid somewhat less than would be expected  relative to GNP, 
while Luxembourg and Germany 'over' -paid. If market exchange-rates are used instead of 
purchasing-power parities, Denmark is found to have underpaid, while Portugal_ and Greece 
slightly overpaid. Table 5.3 relates VAT payments per capita with GDP per capita and shows 
a relatively high positive relationship between the two. It would appear that the adjustments 
made to VAT contributions since  1988 hci·· 1e resulted in VAT payments bearing a closer 
relationship to ability to pay. 

5.47  Even if VAT is not as regressive as is sometimes thought, it is true that VAT payments are 
influenced by many factors giving rise to inequities between Member States.  As observed 
earlier in this report,  the level of a Member State's VAT payments depend on the ratio of 
private consumption spending to GNP, the ratio of public to private consumption spending 
and the net trade balance for manufactured goods. 

5. 48  A further objection to a shared VAT is that, despite rising consumer spending, its proceeds
may not be sufficiently buoyant. To the extent that private consumption spending grows at 
slower rate than GNP within the community as a whole (as happened in the 1970 and 1980s 
when the share of the public sector increased), an own resources system based on VAT will 
not produce a growth in revenues in line with income. As the experience of the EU in the 
I 980s demonstrated, this necessitated constant increases in the VAT rate, which could only 
be achieved by unanimous agreement of all the Member States. 

How might it work? 

5.49  If a shared VAT along the lines proposed in the Langes Repon were adopted. it would be 
possible to adjust Member States' VAT payments to achieve greater tax fairness. There have 
been  numerous suggestions for  how  this could  be done.  One way  is  to  correct for  any 
inequities by using a progressive key or GNP-adjustment mechanism. The application of a 
progressive  key  to  VAT  contributions  was  suggested  by  the  European  Commission 
(European Commission, 1978), an idea first put forward in the  1977 McDougall Repon. It 
proposed adjusting  each Member States' VAT contribution  wholly or partly by a factor 
related to differences in GDP per capita. Denton ( 1983) showed that, if I 00% adjusttnents 
were made, at one extreme Gennany would pay 49% more, while at the other Ireland would 
pay  59%  less.  However,  adjustment  of  less  than  100%  might  be  considered  more 
appropriate. 

34 

.ble 5.1: Actual and Expected VAT Payments. 1988-1995 (MECU) 

:ounti:· 

Belgium 

Denmark 
Germany 
Greece 

Spain 
France 
Ireland 
Italy 

Luxembourg 

· .. rlands

,!;ii

,. ,i1ted Kingdom 

Actual VAT 
Payments (MECU) 

8363 

4900 

77519 

3777 

22354 

55601 

2003 

38906 

691 

13484 

3601 

22626 

Expected VAT 
Payments• 
(MECU) 
' 
8152 

4231 

61617 

4769 

22173 

46892 

2087 

44383 

456 

11622 

4782 

42661 

212 

669 

15902 

-992

181

8709

-84

-54TI 

234

1862

-1180 

-20036

EUR-12 

253826 

253826 

.. 

calculation is based on GDP at PPS 
ourcc: South Bank University; data: EC & Eurostat 

"able""S.2: Actual and Expected VAT Payments, 1988-1995 (MECU) 

Overpayment 
88-95
Total (MECU) 

Overpayment 

Overpayment 

Annual Average  Annual Average 
ECU per capita 

(MECU) 

26 

84 

1988 

-124

23

1089 

-10 

-685

29

233

-148

-2504

.. 

2.6 

16.2 

24.8 

·12.1

0.6

19.0

-3.0 

·12.0

75.0

15.4

-43.3 

.. 

Actual VAT 
Payments (MECU) 

Expected, VAT 
Payments•• 
(MECU) 

Overpayment 
88-95 
Total (MEctJ) 

Overpayment 
Annual Average 
(MECU) 

Overpayment 
Annual Average 
ECU per capita 

Counuy 

Belgium 

Denmark 

Germany 

Greece 

Spain 

France 

lrelanci 

ltalv 

: :i-..embourg 

Netherlands 

Portugal 

United Kingdom 

8363 

4900 

77S19 

31n 

22354 

55601 

2003 

38906 

691 

13484 

3601 

22626 

EUR-12 

.. calculation 1s based on GDP at market exchanee rate

Source: South Bank University; data:  EC & E.;rostat

253826 

161 

-474 

7S54 

230 

3037 

6471 

82 

-2657

215

1408

520 

20 

.59 

944 

29 

380 

809 

10 

-332

27

176

65 

.. , 

-16548

-2069

2.0 

-11.5

11.8

2.8

9.7

14.1

2.9

-5.8

68.8 

11.6 

6.6 

-35.7

8202 

5374 

69965 

3547 

19317 

49130 

1921 

41563 

476 

12076 

3081 
39174 

253826 

35 

Table 5.3: Average GDP and Actual VAT per capita.  I 988-95 

Country 

GDP * per capita  VAT per capita 

Luxembourg 
France 
Germany 
Denmark 
Netherlands 
Belgium 
Italy 
Spain 
Ireland 
United Kingdom 
Greece 
Portugal 

23837 
16725 
15682 
16694 
15677 
16584 
15907 
11606 
12009 
15029 
9475 
9846 

* GDP at PPS
Source: South Bank University; data: EC & Eurostat

221 
122 
121 
119 
Ill 
104 
85 
72 
71 
49 
46 
45 

36 

5.50  Alternatively, the adjustment could be made on the basis of GDP only or size of population 
only.  It would  also be necessary to decide whether market exchange-rates or purchasing 
power parities should be used for making GDP comparisons. The latter would be generally 
considered economically the more meaningful. The Langes Report similarly proposes that 
a GNP adjustment mechanism be used to achieve greater tax fairness (EP,  1994 ). 

5.51  An important consideration is whether the adjustment should be applied to VAT payments 
only or to the level of payments of all three own resources (assuming that the GNP-based 
fourth resource is replaced). The Langes Report appears to favour an adjustment to the GNP 
equivalent of all tax revenues, whereas in its 1978 discussion document, the Commission 
insisted  that  the  adjustment  should  be  applied  to  VAT  payments  only.  It  is  perhaps 
interesting to note that a similar system is used in Germany for equalising VAT payments 
as between  rich and poor Lander. 

5.52  The solution adopted by the EU at the Brussels Summit of 1988 was to cap the VAT base 
at 55% of GNP and to place greater reliance on GNP-based contributions. However, capping 
the  VAT  base  and  increasing  reliance on GNP-based  contributions  militates against  the 
objective of achieving greater financial independence for the EU. 

Environmental/Energy Tax 

5.53  Proposals for some kind of environmental or 'eco' tax imposed at the EU level have existed 
for some while. The European Commission's 1978 discussion document, 'The Way Ahead', 
in  reviewing  the prospects for  new  revenue  sources,  included  energy  taxes  among  the 
possibilities it considered. The idea of an EU-wide energy tax returned to the agenda in 1991 
when the Commission adopted a proposal from Carlo Ripa di Meana (Energy Commissioner) 
for a two-part tax and was one of the preferred options for a new own resource retained in 
the Commission study Stable Money,  Sound Finances (CEC, 1993). 

Wha1 is it? 

.  , 

5.54  Under the general  heading of an eco-tax,  a wide range of different instruments could be 
envisaged,  and this has tended to confuse the debate  on  their  potential  validity as own 
resources. Options range from comprehensive impositions on use of energy and identifiable 
pollutants to much more narrowly targeted taxes on specific types of pollutants. Predictably, 
the  attributes  of  an  eco-tax  and  any  appraisal  of  its  suitability  can  vary  substantially 
depending on the form of the tax that is chosen. 

5.55  The Commission's 'carbon tax' proposal envisaged a levy which was to start at $3 a barrel 
of oil equivalent in 1993 rising to $10 a barrel in 2000. It would fall half on the fuel content 
of all non-renewable energy and half on its carbon content. This would mean that nuclear 
power stations, for example, would be taxed at half the rate levied on electricity from oil­
burning stations.  The tax was  put forward as part of an energy plan designed to stabilise 
CO2 emissions within the EU at 1990 levels by the year 2000. The inclusion of a non-carbon 
part to the energy tax would help to  avoid a substitution to  nuclear power. although the 

37 

-, 

Commission's justification was in terms of the need to increase energy efficiency. There 
were to be exemptions for energy-intensive industries such as chemicals, steel, cement and 
paper to avoid adverse effects on the competitiveness of European industry. On the other 
hand, since these industries were the heaviest users of non-renewable energy resources, they 
should on grounds of economic efficiency be subject to inducements to reduce the energy­
intensity of their output. 

5.56  Because of strong opposition from fuel producers and other industrial groups,  the tax was 
made conditional upon other countries - the US and Japan - adopting similar measures to 
curb carbon dioxide emissions.  However, at the Earth Summit in Rio do Janeiro in June, 
1992, due largely to US opposition, no binding agreement on CO2 emissions was reached. 
Subsequently, the proposal for a carbon tax was abandoned. 

5.57  More narrowly defined variants on what would now be regarded as eco-taxes exist in nearly 
all Member States, most obviously excise duties on mineral oils, especially petrol and diesel 
fuel. Charges for land-fill and other forms of waste disposal are emerging as favoured tax 
instruments, and there are levies in some countries on domestic energy use. Other forms of 
eco-tax that might be imagined include levies on pesticides and fertilisers, higher charges for 
clean water or even some form of tourist tax. 

Principal attractions as a  'European ' tax 

5.58  A  major  reason  for  assigning  environmental  taxes  in  general  to  the  highest  tier  of 
government is that environmental taxes applied at lower levels give rise to sizeable spillover 
effects on neighbouring jurisdictions. If externalities resulting from pollution were confined 
to the territory of a single state, subsidiarity principles would favour leaving it to individual 
countries to levy their own pollution taxes or to administer their own forms of regulation as 
deemed  appropriate.  However,  many forms of pollution have wider effects  such  that  the 
benefits  of  measures  taken  by  any  one  country  are  enjoyed  by  others  without  any 
requirement to contribute to the costs of such measures. The creates the opportunity for some 
countries to 'free ride' on the gains from measures taken by other countries and paid for by 
producers and consumers in those countries. 

j_59  The  Langes Report  (1994)  argues that  there  may be a good  'educational'  argument  for 
considering this option.  Such a tax could  play  a useful  role in  bringing about changes in 
consumer behaviour in conformity with some of the agreed objectives of the EU. Thus, the 
EU has made a strong statement regarding its commitment to a sizeable  reduction  in the 
global of carbon-dioxide emissions in an effort to avert global warming. To the extent that 
the measures taken at individual Member State level are inadequate, action at the EU-wide 
level is well grounded. 

5.60  At  the same  time,  where  environmental  taxes are determined at  the level of  individual 
Member States, there is the possibility that Member States may engage in tax competition 
in an effort to attract pollution-intensive industries to their own territory. Member States with 
higher levels of pollution tax may then feel obliged to lower their tax levels to prevent a loss 
of investment. It follows that the tax decisions of any one Member State can inflict losses on 
other Member States. 

38 

5. 6 I  These problems could be resolved by tax coordination rather than through the introduction
of  an  EU  environmental  tax.  For  example,  so-called  'eco-dumping'  can  be  tackled  by 
agreeing minimum environmental standards for all  countries. Likewise, tax competition can 
be  resolved  by  agreeing minimum tax  rates.  Indeed,  this  is the approach currently being 
developed  by  the  Commission.  In  February  1996,  the  Commission  introduced  a  draft 
directive proposing the setting of minimum tax rates for coal,  natural gas and electricity. 
Minimum tax rates already exist on petrol, diesel, heating fuel and heavy fuel. 

5.62  There are other arguments in favour of a EU-wide carbon tax. It could constitute a useful 
bargaining  counter  in  international  negotiations to  secure  agreement  on  carbon-dioxide 
emissions. Another consideration is that nationally-based eco-taxes might distort competition 
within  the  Single  Market.  Environmental  taxes  might  be  introduced  in  order  to  give 
protection to national producers in a particular Member State.  In  1989,  the Commission 
threatened to take the Dutch to the European Court of Justice because they had granted tax 
concessions to buyers who purchased cars fitted with catalytic converters. It was argued that 
the measure discriminated against producers in other Member States who has been slower 
in adapting their cars so that they could be easily fitted with converters. 

Disadvantages 

5.63  That  Eco-taxes  have  drawbacks  is  evident  from  the  fact  that  their  introduction  has 
consistently  been opposed,  a key  objection  being the  need  to take  into  account  national 
diversity of preferences. The principle of subsidiarity favours assigning taxes to the Member 
State level unless it can be demonstrated that other considerations render it more efficient 
to operate  such a tax at the EU level.  Clearly,  differences do exist between the Member 
States with regard to environmental standards. In general, richer Member States are likely 
to attach much greater importance to environmental quality than poorer Member States. 

5.64  Smith (1993) suggests that the assimilative capacity of the environment may also determine 
the optimum level of pollution control. Thus, countries such as the UK with fast-flowing, 
shon rivers may be able to tolerate higher levels of industrial effiuent discharge than other 
regions with  longer waterways.  To  the extent that national preferences diff�r,  it may be 
argued  that  it  is  preferable  to  leave  the  imposition  of  environmental  taxes  and  the 
administration of pollution controls to the Member States. It might also be argued that, since 
eco-taxes are relatively new policy instruments. it would be better to experiment with their 
use at the national level before assigning them to a higher tier (Spahn,  1993). 

5. 65 There may also be a problem of regional arbitrariness of revenues from an eco-tax if the tax 
is imposed at the Member State level. This may be illustrated by contrasting  a tax imposed 
on the proffuction of energy with a tax imposed on consumption.  It is widely considered that 
a primary ·carbon tax imposed at an early stage in the production chain is the most efficient 
way of levying such a tax. There are fewer taxpayers so that administrative costs are lower. 
At  the  same time,  a  tax  on final  consumption confronts  the  problem that  some  energy 
entering into production is lost in the process of refining. However, the two alternatives will 
result  in  an  entirely  different allocation  of  revenues  as between  the  Member  States.  A 
primary  carbon  tax  will  fall  on  countries  ,vhich  are  large  energy  producers  (the  UK, 

39 

,--

Netherlands)  while  a  tax  on  consumption will  most affect  countries  with high  levels  of 
consumption and large imports. 

5.66  On  equity grounds,  too,  the tax  is open  to challenge. Work by the Commission yielded 
estimates of the revenue effects of a $1 O carbon tax by Member State. This shows Greece 
and  Ireland as  the  two  largest contributors and France  and Spain as the two smallest.  It 
would, however, be possible to apply a suitable adjustment mechanism to correct for these 
imbalances or some other system of compensatory payments. 

How might it work? 

5.67  Estimates by  the  European  Commission  suggest  that a carbon tax  of $10 a barrel of oil 
equivalent could generate revenues equal to about  I. 1% of GDP, more than sufficient to 
cover the EU' s financial needs (European Economy,  1993). However, an obvious problem 
with such a tax is that it is likely to be degressive (i.e. tax  revenues are likely to fall over 
time).  As  the  Langes  Report  (1994)  concluded,  this  renders  it  unsuitable as  a  source of 
revenue for the EU. However, energy use correlates quite closely with GDP growth, so that 
these concerns may  be exaggerated. 

5.68  Given  the  widespread use of excise on petrol and diesel,  this might be a more attractive 
means of establishing an eco-friendly own resource. These taxes currently yield 3% or more 
of the tax take in  different EU Member  States.  An earlier suggestion to impose a tax on 
imported oil was rejected as unfair on those Member States most dependent on oil imports 
and likely to provoke retaliation by oil-exporting countries. 

Alcohol and Tobacco excises 

5. 69  Harmonisation of excise duties on alcohol and tobacco was part of the original single market
programme, but resistance from certain Member States has meant slow progress towards this. 
The  Commission's  1997  Action  Plan for  the  Single Market  again  promises  action  to 
'eliminate  significant  distortions  in  the  area  of indirect  taxation'.  These  excises  raise 
substantial amounts of money in all Member States and are regularly cited as potential own 
resources. 

What is it? 

5.70  Proposals  for a  EU  tax on  social  'bads'  or  'demerit  goods'  such  as  alcohol or tobacco 
consumption have a long history. In  1978, the Commission in its 'The Way Ahead' document 
included such a tax in  its review of possible new revenue sources.  It estimated that 0.15 
EUA  tax  on  a  packet of cigarettes  could raise  the equivalent  of 0.30%  of Union  GDP 
compared with  0.82% of GDP accruing from  all  the then-existing tobacco taxes.  It also
estimated that,  if the revenues from all existing alcohol taxes were to accrue to the Union,
this would produce the equivalent of 0.6% of Union GDP. 

5. 71  The Langes Report (EP, 1994) included such taxes as examples of 'educational tax.es'_which
it may be desirable for the EU to impose at a European-wide level to _make goo_d deficiencies
in national measures.  However,  it acknowledged that they  were  mappropnate as central

40 

sources of revenue  because of their degressive nature. Such products typically have low 
revenue  elasticities  with  respect  to  GNP  (because  taxes  are  usually  defined  in  terms  of 
quantities rather than values). On the other hand, revenue elasticities are high in relation to 
rate increases because the demand for such goods is typically price inelastic (Spahn, 1993). 

Principal attractions as a  'European · tax 

5. 72  The main arguments for alcohol and tobacco excises as own resources are that they would
be  easy  to  introduce  and  would  be  able  to  generate  sufficient  revenue.  They  would,  in 
addition, be expected to improve economic efficiency. Support for centralising excise duties 
at the EU level  comes from the observation that most other federations have done so.  In a 
Single  Market,  big  differences  in  tax  rates  for such  goods  could  induce  economically 
inefficient cross-border shopping.  This could lead to a tax competition between Member 
States in which those with high tax rates lose revenue (and economic activity) to countries 
with lower rates. This could trigger a 'race-to-the-bottom'  driving rates in the EU as a whole 
below socially optimal levels. However, this can be avoided by agreeing minimum rates of 
taxation without any necessity for the taxes to be imposed at the EU level. 

..). 73  The measures agreed  within the EU for  minimum rates of  tax have been introduced for 
precisely this reason. In 1991, a minimum tax rate on cigarettes of 57% of the retail price and 
on beer of ECU 1.87 for every one degree of alcohol for every  100  litres  was  agreed. In 
I 992, a two-tier system of duty on spirits was agreed and, again in 1992, similar agreements 
were reached for wine and sherry. The Commission's original 1987 proposals for a single 
rate  of  excise  duty throughout the EU following  the elimination of border controls was 
rejected by the Member States. 

Disadvantages 

5.74  Equity considerations constitute the principal objections to these excises as own resources. 
They would not only fall relatively heavily on the least-favoured Member States, but are also 
acknowledged  to  be  regressive  because  the  incidence  of  the  tax  is  greatest  on  poor 
individuals.  Social  fairness  would  also  be  compromised  by  the  obvious  fact  that  only 
smokers and drinkers would pay the tax. 

5. 7 5  A further objection is that,  as specific duties,  rates of tax would need to be changed from
time to time either to compensate for inflation or to adjust for changes in spending patterns. 
Although demand for alcohol and tobacco is notoriously inelastic. the buoyancy of revenues 
could not be assured. 

5.76  Differences in tax rates can still exist after frontier controls have been abolished without 
giving rise to serious externalities. Moreover,  the existence of very different rates of tax on 
such goods to some extent reflects different national preferences. For example, Denmark, 
Ireland and the UK have traditionally taxed cigarette and alcohol consumption more severely 
than Greece or Spain. In the light of this, the principles of fiscal federalism discussed above 
would favour assigning to the lower tier in order better to reflect such divergences in local 
preferences and interests. Moreover, the strong resistance waged by the Member States to 

41 

the efforts of the Commission to harmonise such  taxes augurs badly for any  attempt to agree 
an EU-wide tax  on  alcohol or cigarettes. 

How might it work? 

5. 77  The option most likely to appeal to the Member  States would be for the EU to take a share
of the  revenues collected from these excises. For example, an EU tax equivalent to 25% of 
the sales price of a packet of cigarettes would mean that each Member State would keep at 
least half of the revenues raised from the tax, because its rate is agreed as a minimum of 57¾ 
of  the  price.  Since Member  States  would  be  free  to  charge  whatever  additional tax they 
wished,  the  loss  of  n ational  sovereignty  would  be  minor.  A  similar  approach  could  be 
adopted for  alcohol.  Such a tax  could  be  expected  to provide substantial  additional fiscal 
revenues. 

5.78  It  would,  however,  require  further  progress  to  be  made  in  reaching  agreement  on  a 
harmonised  base  for  assessment  of such  taxes  throughout  the  EU.  There  would  also be 
obvious inequities  between the  Member  States  with Member  States  with  larger  levels of 
spending  on  alcohol  and tobacco relative to  GNP making larger payments to  the EU. 

Using  Seigniorage Revenues 

5. 79  Central banks in most countries enjoy the unique privilege of being  the sole issuer of notes
within the economy. This  allows them to earn monopoly profits from  their  activities as note­
issuers. These so-called seigniorage revenues arising from the profits central banks generate 
constitute an important source of revenue to  governments, particularly during  periods of high 
inflation when nominal interest rates tend to be higher6. 

What is it? 

5.80  Seigniorage  revenues  arise  because  the  notes  issued  by  the  central  bank  to  the  public 
constitute  liabilities  on which the central bank pays no interest,  but  are offset by central bank 
holdings of various kinds of interest-bearing assets, mostly in the form of government debt. 
Conceptually, these revenues can  be measured in one of two ways. The first is given by the 
size  of a  country's monetary base (notes  and  coin in circulation with the public plus cash 
reserves held by  commercial banks). The  second is the difference between  the market rate 
of interest earned b y  the central  bank on  debt held and  the interest rate paid  on  liabilities 
issued (zero on notes issued to the public but possibly positive on  some  cash  reserves  owned 
by banks). The latter is broadly equivalent to the profits  of the central bank. 

5. 81  The  adoption  of the Euro as  Europe's common currency  will mean  a  loss of seigniorage
revenues  for  individual  Member  States.  These  losses  will  be  greatest  for  countries  with 
relatively high inflation. Emerson (1992) estimated these revenues at close to 0.5% for most 
EU Member States,  but  higher for Ireland,  Spain,  Portug al  and Greece.  Figures quoted in 

6  Because  of this link.  such revenues are sometimes also referred to as an injlarion  tax. 

42 

Stable Money, Sound Finances (CEC, 1993) are more circumspect, suggesting the proceeds 
will be at most 0.4% of GDP and will tend to fall if EMU succeeds in curbing inflation. 

5.82  In principle,  seigniorage  revenues  lost by  the  Member  States  individually  would accrue 
instead to the EU as a whole assuming that all countries join the final stage of EMU. The 
creation of the European System of Central Banks (ESCB) comprising the European Central 
Bank (ECB) and national central banks (NCBs) is governed by a Protocol to the TEU which 
states  (Article 32)  that the profits of the  ESCB  will  be  disbursed  in  proportion to share 
holdings. It has been suggested that these profits could, instead, be used as additional own 
resource for the EU. 

Principal attractions as a  'European ' tax 

5.83  The main argument for doing so is that in an integrated currency area,  there is no obvious 
key for apportioning seigniorage revenues to Member States. This is because the monetary 
base can no longer be separated into the different parts  'belonging'  to different Member 
States. One aspect of this concerns the cash reserves of the commercial banks. The size of 
these reserves held with a particular NCB would depend enti1ely on the level of deposits held 
with banks in the Member State in question. In other words, the distribution of seigniorage 
revenues will depend entirely on where the public place deposits with banks. 

5.84  As Spahn (1993) has put it, we have here an equivalent of the 'Rotterdam-Antwerp effect' 
for  customs  duties,  which  would  make  seigniorage  revenues  a  good  addition  to  own 
resources.  Furthermore,  because  seigniorage  revenues  accrue  from  the  operation  of a 
common policy of the EU, it may be considered appropriate that they should flow to the EU 
and not the  Member States.  There is the further advantage that  they  would be relatively 
costless to collect. Moreover, because the tax is an implicit one, it may be politically easier 
for Member  State governments to assign the tax to the EU than in the case of other more 
oven taxes. 

Disadvantages 

5.85  As Spahn  (1993)  has  noted,  it can  only  be  a  matter  of time  before  these  revenues  are 
assigned to the EU as, within the context of EMU, they cannot legitimately be regarded as 
belonging to the Member States individually. However, seigniorage revenues have obvious 
drawbacks as own resources. The main one concerns the distributional effects. As  noted 
above, the NCBs with the highest seigniorage revenues are those of the Member States with 
the highest inflation rates. Although this might seem a useful system for deterring excessive 
inflation., these countries tend to be among the poorer Member States. The effects could be 
regressive,  �!though EMU should, in principle, lead to a common inflation rate. The less­
favoured countries may, nevertheless,  be penalised if risk premia continue to be charged on 
their interest rates 

5.86  Another  problem  is  that  unless  all  Member  States  participate  in  EMU,  there could  be 
political problems. It would be much less obvious to the citizens of these countries why the 
profits of the NCB should be paid over to the EU. Finally, the tax would suffer from lack of 

43 

visibility in the eyes of the taxpayer. Since it is essentially a concealed one, the taxpayer 
would be unable to see any relationship between the amount being paid to the EU in taxes 
and  the bundle  of  public goods  and  services received in return. Thus,  the tax would do 
nothing to enhance accountability. In this respect, it scores no better than a system based on 
Member State contributions and may,  indeed, be more opaque. 

How might it work? 

1 

5.87 The administration of the tax would be simple, as it would involve no more than the ESCB 
handing over its profits. However, a Treaty change to alter the Protocol on the ESCB would 
be needed. If this can be achieved without undue difficulty, making seigniorage revenues an 
own resource might seem quite attractive, although they are likely to emulate traditional own 
resources in producing a declining yield. 

New Communications Taxes 

5. 88  One of the consequences of the establishment of the single market has been to add to the
volume of transport and communication traffic across the EU. Market liberalisation measures 
have been reinforced by specific policies emanating from the EU to improve networks (such 
as  the  TENS  programme),  while  regulation  of  transport  and  telecommunications  has 
increasingly shifted to the European level. A tax aimed specifically at this tax base might, 
therefore  be  warranted,  even  if it represented  a  new tax and might be subject to  initial 
resistance.  Equally,  from  the  perspective  of visibility,  a  new  tax  could  well  have  the 
advantage of being more easy to project as an authentic 'Euro-tax'. 

What is it? 

5.89  Prospective Europe-wide communications tax bases include road transport,  air transport, 
telecommunications in all its forms and, possibly,  broadcasting. Sea and rail transport can 
probably  be  dismissed as  being  unevenly spread geographically,  and  having  favourable 
environmental  characteristics  that  governments  want  to  encourage.  Three  possible 
communications taxes are based on the following. 

• There were some 175 million telephone lines in the EU in 1993, a number that has since
grown with  the  growth of mobile  services,  the proliferation of new services and the
expansion of business use. Industry forecasts suggest that by the year 2000, this will
have grown to over 250 million.

• Road  taxation  is  increasingly  been seen  as  an  inevitable response  to  the  growing
congestion affecting all Member States. The ever-expanding number of vehicles on the
roads and environmental objections to new road building point to further aggravation of
these problems. According to Eurostat, the EU car 'fleet' in 1994 totalled 157 million
with a further  18 million commercial vehicles.

• .-'\ir transport is also a rapidly growing industry, with annual growth rates of passenger
traffic in recent years of around 5%.  In  I 996,  there were approximately 500 million
journeys made in the EU, and this could be around a quarter higher by the year 2000.

44 

Principal attractions as a  'European · tax 

5. 90  All the fonns of communication cited are expanding sectors of economic activity so that they
could be expected to generate growing yields. However, care would be needed in the details 
of any such tax to ensure that it did not unduly inhibit cross-border communication or fall 
disproportionately on partn:ular Member States. An imposition on basic telephony would 
appear to be attractive, since telecommunications revenues appear to be correlated with GDP 
(Table 5.4). Similarly,  the number of vehicles is linked to income while air travel tends to 
be greatest amongst the richer. As these taxes would fall partly on business as well as on 
consumers, it would strike a balance between consumers and businesses as tax-payers. For 
all these reasons, the proposed resources ought to 'perform' well on equity criteria. They 
would also bear less heavily on prospective new Member States. 

5.91  For  both  air  travel  and  vehicles,  a  tax  collection  already  takes  place  in  most  countries, 
although rates would need to be harmonised. A telephony tax would require the construction 
of  a  new  tax,  but collection costs  ought  to be modest if  it  is  administered through  the 
telephone  operators.  Overall, 
the  administrative  characteristics  of 
'communications' taxes should be relatively favourable. 

therefore, 

5.92  In principle, the nature of the tax bases would make evasion or fraud unlikely and revenues 
ought to be acceptably stable. A further possible advantage of a new tax instrument would 
be to highlight the visibility of EU activity. 

Disadvantages 

5.93  A transfer of tax revenues that also requires changing the rates for some Member States (as 
in a harmonised airport departure tax) will encounter objections. This could be compounded 
if  an entirely  new  tax  is introduced (as in the proposed telephony charge),  although the 
political costs would probably be short-lived. Having multiple taxes might also be a problem. 
It is,  however,  open to question whether such sensitivities on the part of Member States 
would be severe obstacles. 

5. 94  Current statistics suggest that prima facie the incidence of air travel is somewhat uneven as 
between Member States, but the nature of air travel makes it difficult to interpret these data. 
A holiday flight from Germany to Greece would show up as a departure from both Member 
States,  but  in  both cases  it would be Gennan residents who paid the .tax.  Equally, major 
gateways such as Heathrow, Paris or Amsterdam will record departures by passengers who 
are from other Member States and often from outside the EU. Interpretation of air traffic 
figures  could  be problematic,  although  the  difficulties  lend  support  to the  case  for  not
apponioJiing revenues by Member State. 

5.95  There may be some concern that taxing communications would be contrary to the spirit of 
the  single  market  and  might  penalise  rural and  peripheral  areas.  There  may  also  be  a 
perceived conflict with the long-term goal of enhancing EU competitiveness that underpins 
the TENS initiatives. 

45 

How might it work? 

5.96  The three options cited (a telephony tax, roacf� and airport departure tax) would operate 

. 

-··· 

.  _::p 

in related but distinct ways. 

• An average imposition per line of around 40 ECUs per year on the 250 million or more
telephone lines expected by the year 2000  would yield ECUs  10 billion at 1997 prices,
and would be a buoyant source as the number of lines continues to expand.

• Although Member States differ markedly in the manner in which they tax vehicles,  there
is  plainly  scope  for  raising  substantial  revenues  from  this  source.  In  the  UK,  for
example, vehicle excise duties are forecast to raise  1.5% of general government receipts
in the UK, about 0.56% of GDP.

• Airport taxes  on  passengers differ  substantially,  but have been on an  upward  trend.
Frequent travellers through Brussels will know that the rate is now BFr 600 (ECUs 15,
approximately); France charges FFr 25 (ECUs 3.75), while the UK has just announced
an increase to £10 for intra-EU journeys and £20 for others (ECUs  15 and 30). It is also
noteworthy that the US  imposes much higher rates, and  has just announced (August
1997) further increases. For airport departure taxes, an average tax of ECUs  15, accruing
entirely to the EU,  could be expected to raise about ECUs  10  billion at  1997 prices
assuming continuing growth in air traffic. Whether to impose a differential rate for extra­
EU, or even extra-European travel would be a matter of judgement.

Table 5.4: Telecommunication Revenue/ GDP · (1995) 

Country 

Ranking 

Portugal 
Ireland 
Sweden 
United Kingdom 
Greece 
Denmark 
Netherlands 
Finland 
Germany 
Spain 
Austria 
Italy 
France 
Luxembourg 
Belgium 

0.028 
0.027 
0.026 
0.026 
0.024 
0.022 
0.021 
0.020 
0.020 
0.020 
0.019 
0.018 
0.017 
0.017 
0.016 

• GDPatECt;
Source: South Bank University; data: Eurostat. OECD & ITt' 

46 

6  A comparison of the options for reform 

6.1  This  section brings together our discussion of the eight options into a single framework to 
explore which best meet the requirements for a reformed system of own resources. Before 
comparing the options in teill}S of the criteria set out in Section 4,  the political and economic 
options need to be considered. 

6.2  On the asswnption that the two traditional own resources remain valid, there are two broadly 
feasible alternatives. The first is to seek a new third resource to replace the existing third and 
fourth ones. This would have to raise the bulk of the EU's revenues. Alternatively,  any new 
resource could be added to the existing four, one effect of which would be to diminish calls 
on  the  present  fourth  resource.  This  has  been  proposed  from  time  to  time  by  the 
Commission, although thus far without success. The Commission concedes, in Agenda 2000, 
that even the addition of a new own resource would fail to increase the financial autonomy 
of the EU as residual financing would continue to be covered by Member State contributions. 
Only if the whole of the EU budget were financed from genuine own resources would true 
financial autonomy be achieved. 

6.3 

In  proposing  to  retain  the  existing  1.27%  of  GDP  ceiling  for  the  period  2000-6,  the 
Commission argues in Agenda 2000 that this will provide the EU with sufficient finances to 
meet all its commitments. On the assumption of an economic growth-rate of 2.5% a year in 
the  existing fifteen Member States and 4% a year in the countries which have applied for 
membership, it estimates that this will produce additional annual resources in excess of ECU 
20 billion by 2006. 

6.4  The composition of these is, however, important. The Commission estimates that, by 1999, 
traditional own resources will have declined further in importance to account for only  15% 
of total EU revenues.  It expects  the share of VAT payments to decline further to 33% of 
revenues with the GNP-based contributions having to yield the remainder. Assuming that the 
share of traditional own resources remains stable, the replacement of VAT and GNP-based 
connibutions with a new own resource will require it to yield revenues of roughly ECUs 95 
billion at  1997 prices  by  2006.  To the  extent  that  either a VAT resource  or the GNP are 
retained, the yield required of a new resource will be smaller. 

6.5  As noted above, the fact that the EU is able to finance its activities,  coupled with the decision 
in Agenda 2000 to freeze the current ceiling argues forcefully for the retention of the status 
quo. Indeed, hard political logic would suggest that unless there is a pay-off in terms of a 
higher budget,  the case for seeking a reform or enhancement of own resources is weak. 
However, the purpose of this study is to look beyond the current political accommodations 
to consider how own resources might be developed. While recognising the current political 
constraints on any evolution of the system, therefore, appraisal of options for reform has to 
start from a different point, namely what questions arise if or when reforms of own resources 
are undertaken. These include: 

• Should sufficient own resources be assigned to cover  100%  of the EU budget for the

forseeable future?

47 

• Is it better to seek a single revenue instrument or a basket of them?

• Should the aim be to reassign an existing tax, or can new taxes be envisaged?

• If a tax is shared with other levels of government, would this weaken ownership of the
resource in a way that undermined the transparency of the system for financing the EU?

• In  the  interests  of  'fairness',  however  defined,  are  mechanisms  needed  to  correct

inequities in contributions?

Comparing the options 

6.6 

6. 7 

It is not easy to decide how to select an ideal tax instrument. The choice involves not only 
differing combinations of costs and benefits, but also subjective as well as objective criteria. 
Moreover, there may be aspects of a tax which, although marginal in an objective sense, can 
be of over-arching importance in political tenns, the more so in the EU context. 

It is imponant to stress that, so long as there is an own resources ceiling, any reform of the
financing of the EU that saw new own resources replacing existing ones would be 'revenue 
neutral'  in that  the  imposition  of a new  tax  would  permit  reductions  in  taxes  currently 
assigned to the EU. Although there might be hostile political and press comment, the fact 
that Member States would be able to reduce other taxes is a crucial element in the discussion. 
A future European Council could choose to alter the ceiling, but that would be a separate 
political decision and would not directly affect the choice of tax to be used as own resources. 

6.8  Different philosophies could also be adopted in selecting own resources, such as whether to 
seek an instrument assigned exclusively to the EU or to countenance sharing the proceeds 
between the EU and lower tiers of government. The former would best achieve the aim of 
making the tax visible to citizens, but it is not that hard to do so with a shared tax. 

6.9  Whether  or not to  effect some form  of equalisation to correct for  any  imbalance in the 
incidence of the tax is also an issue. On past experience, the principal dimension of fairness 
would be between Member States, but other facets of equity, such as between regions or 
social groups might also warrant attention. With some prospective own resources, attribution 
of the tax proceeds by Member State may, moreover, be hard to document. 

6.1 O  The analysis which follows puts forward both a methodology for appraising different options 
for own resources and the results of applying it to the eight options described in the previous 
section of the report. For each of the options a two page summary of its characteristics is 
presented.  This  provides,  first,  an overview of  the  main features of  the  proposed  own 
resource and,  second, a quantitative assessment of the tax against the criteria outlined in 
section 4 of this report. 

Methodology for comparing options 

6.11  The various criteria for assessing possible own resources, grouped under the three headings 
of' economic', 'administrative' and 'political'  described in section 4, form the basis for a 

48 

quantitative scoring. In the tables which follow the computation is a two stage process. The 
first stage  of the  scoring  is  to  attach  weights  to  each  criterion to  reflect  its  perceived 
importance in the  assessment. These are based on the judgements of the project team. It 
should be noted that the same weights have been used for each proposed own resource and 
that the total adds up to  1000. Thus, the criterion of equity between Member States has been 
given a weight of 100 out of 1000, as has that of Member State sensitivities. 

6.12  For the various proposed tax instruments, each criterion is then given a rating on a five point 

scale to be interpreted as follows: 

- Strongly favourable
- Favourable
- Neutral
- Adverse
- Strongly adverse

+2
+ 1
0
-1
-2

These ratings have, again, been arrived at on the basis of judgements by the project team, 
drawing on economic analysis, empirical results and past research,  together with political 
input. We acknowledge that there is a degree of arbitrariness in these scores,  but would also 
point out that the reader can see precisely how they have been arrived at and can easily work 
out the consequences of awarding different scores. 

6.13  The weighted score for each criterion is the product of the  weight and  the rating.  As an 
illustration, income tax scores 200 on the criterion of equity between Member States, while 
on the Member State sensitivities test the score is -200. These scores are then summed for 
each group of criteria and an overall score is calculated. 

6.14  These scores are, in principle, objective, but because they  reflect judgements they are bound 
to be open to challenge. Different weights or rankings will yield different outcomes, and it 
is for the reader to judge how best to use them. For example, if an overall score is positive, 
but there are several criteria that are strongly adverse, this might be considered to be a reason 
to reject the proposed tax. 

6.15  This  scoring  methodology  can  quickly  and  easily  modified  to  incorporate  different 
judgements about weights and rankings of criteria. It can, similarly, be used to evaluate other 
instruments, changes in political priorities or different designs of possible taxes. Different 
assessments  of an  eco-tax  might,  for  instance,  be  given  if global  agreement  on  CO2
abatement pushed this up the political agenda. By the same token,  agreement on harmonising 
corporate law  or  the treatment  of withholding tax would  help to overcome some  of the 
objections to these options. 

Assessments of tlze eight proposed own resources 

6. 16  The two page summaries of each proposed new resource are follow at the end of this section, 
while Table 6.1 summarises and comments on the quantitative scores. F rom this table, it can 

49 

be seen that modulated VAT and communications taxes receive the best ratings and, possibly 
as telling, do not have negative scores in one or more of the sets of criteria. 

6.17  By contrast, income tax and corporation tax, both of which earn tolerably good scores on the 
economic and administra�ive criteria,  fare badly on  the political  dimension.  Alcohol  and 
tobacco taxes fall down on equity criteria, whil� seigniorage has a very mixed set of scores. 
Eco-tax comes out reasonably well, although in this case the precise form of the tax will 
influence how acceptable it is, or could become.  The withholding tax is subject to similar 
concerns,  although in both  instances,  there may  be  scope for refining  the  design of the 
instrument to lessen some of the objections to it. 

50 

Table 6.1 

Summary of quantitative assessment of own resource options 

Proposed own resource 

Economic  Administr-
ative score 

score 

Political 
score 

Overall 
score 

Comments 

Personal income lax 

Withholding tax 

Corporation tax 

Modulated VAT 

Eco/energy tax 

Alcohol/tobacco excises 

Seigniorage 

350 

175 

325 

175 

0 

-100

50 

325 

50 

-400

-100

250 

-200

275 

125 

375 

Favourable rating on economic and administrative criteria,  but 
politically very touchy in EU. 

Not  a  realistic  proposition  at  present,  but  could  become 
feasible with and financial changes 

In principle, a tax that it makes sense to levy at the EU level, 
but  will  need  base  harmonisation  and  efforts  to  enhance 
political acceptability. 

400 

15 

450 

0 

425 

250 

75 

-50

1,000 

VAT is  already used as an own resource, and would gain in 
visibility by being more explicit. 

265 

425 

0 

800 

Potentially suitable tax for the future rather than the present, 
but political opposition and administrative worries. 

Relatively easy to reassign, but too many concerns about its 
uneven incidence. 

Obvious  link  to  EU  policies,  but  has  too  many  negative 
features. 

Innovative  option  for  topping-up  other  resources,  and 
reasonably fair. 

Communications tax 

175 

450 

175 

51 

A Surcharge on Income Tax 

Income taX is often  considered to be most efficiently levied by the highest tier of government and. in 
practice. this is usually the case. The reason is the need to avoid the inefficient location of a mobile 
workforce that may arise  if lower levels of govemment set very different levels of taxation. In the EU. 
however, the workforce is relatively immobile and therefore the traditional argumems possibly do not apply. 
Nevertheless. this tax is often considered as a potential own resource for the Community, because of its 
many benefits, and various  models have been put forward. Such a tax could take the form of a progressive 
surcharge on existing national income taxes. 

Merits 

Drawbacks 

Depending on the rate assigned to the EU. the tax 
could provide revenue sufficiem to meet all the EU's 
funding requirements. 

The lack of a harmonised tax base means that such a 
tax could give rise to inequities either between the 
Member States or individual tax-payers. 

The tax has a high level of fiscal buoyancy, 
revenues being very responsive to changes in 
income. 

The need to  retain sufficiem tlexibility to pursue 
national stabilisation policies after EMU to counter 
asymmetric shocks. 

Member States' payments are related to ability to 
pay. 

Such a tax would be very visible to the tax payer. 
thus strengthening the objective of accouruabiliry. 

Political and Adminiru-ative Factors 

The levying of some form. of income cax at the EU level would face administrative problems because of a 
lack of a harmonised tax base. Further, income taX most acutely defines the relationship between the 
politician and the voter  in each Member State, and the right to set the level of direct taxes is one which 
Member states will seek to defend. 

Assessment 

Quantitative scoring.......................................................................................  Fairly high 

Obstacles to introduction ............... :...............................................................  Medium 

Verdict .•••••••••••••••••••••••••••••••.•••••.••••••••••••....••••••••••••••••••..••••••..•••••••••••••••.•••••.• 

Medium 

52 

Criteria 

ECONOMIC 

Equity between Member States 

Faimess between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Harmonised tax base 

Visibility and accountability 

Link to common policies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

Income  tax 

Weight  Rating 

Score 

Comments 

I 

I 

200 

150 

Closely related to ability to pay 

Progressive rax 

0 

Neutral effect on resource allocation 

350  I Good economic characteristics 

50 

150 

150 

75

-100

325 

-200

-150

100 

Relatively cheap to collect 

Revenue rises strongly with incomes 

Could finance entire  EU budget 

Subject to some cyclical tlucruations 

Prone to evasion 

I On the whole, good  option 

Likely to be opposed by most Member States 

Very diverse at present and would be bard to 
agree 

Visible if added as a separate rate to tax 
declarations of taxpayers 

-100 No obvious direct linkage 

-50

Divergent national preferences favour taxation at 
Member State level 

-400  Would face formidable  poJiµcal obstacles 

275  Good attributes as a tax offset by lack of 

political acceptability 

I

I

I

I

I 

I 

2 

2 

0 

1 

2 

2 
l

-1

-2

-2

I 

-2

-1

100 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

50 

50 

375 

1000 

53 

A European Withholding Tax 

Withholding taXes are imposed by most (but not all) Member States  on dividend and/or interest income paid 
to both foreign and local investors in orde, both ro prevem tax evasion and to ensure that the hose coumry 
govemmem gets a share of any rerum accruing to investors not resident in  the coumry.  Large differences in 
such taxes within the EU may diston the allocation of capital and create opportunities  for tax competition 
between Member States. In  1989.  the Commission proposed the adoption  of  a minimum  15 %  EU 
withholding tax on  domestically  issued  bonds and bank deposit interest but the proposal  was not acceptable 
to either Luxembourg  (which  levied no withholding tax) and the UK  (which  imposed  such a taX on the 
interest income of non-residents only). However.  the proposal could attract sufficiem suppon from the 
Member States in the future. Abolition of taXes on cross-border payments between residents of the EU is, 
anyhow, envisaged as a requirement for completing the Single Market. 

Merits 

Drawbacks 

The presem differences in the caxation of capital 
income  discon the pattern of ponfolio invesanem 
within  the EU. 

Such a tax would be unlikely to raise sufficient 
revenues  on the  basis proposed. especially if the rax 
caused a flow  of funds to rax havens outside the EU. 

The absence of any common rax creates 
opponuniries for tax. competition between Member 
States  resulting in loss of fiscal  revenues for certain 
countries. 

Revenues would be highly unstable flucruating with 
ebbs and flows in inward ponfolio invesanem, and 
in interest rates. 

Such a  tax. would probably be reasonably equitable, 
given that savings levels are  higher in the richer 
Member States. 

Such a tax could be a deterrent to both domestic 
saving  and investmem by non-residents in the EU, 
damaging long-run invesanent and growth 

Political and Administrative Factors 

There would be tew administrative problems but past experience suggests that it might prove difficult to 
secure the agreement of  all  the  Member States to such a measure. This could improve  if legislation to 
promote harmonisation of arrangements is  passed. 

Assessment 

Quantitative scoring.......................................................................................  Low 

Obstacles to imroduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  Medium 

Verdict ......................................................................................................... . 

Weak 

54 

Criteria 

ECONOMIC 

Equity between  Member  States 

Fairness  between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stabiliiy of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Harmonised tax base 

Visibility and account.abilicy 

Link to common policies 

Consistency with subsidiariry 

Sub-total 

OVERALL 

Withholdinl! ttax 

-

Weight 

Rating 

Score 

Comments 

I

I

I 

I 

I 

I 

0 

l

I 

0 

-1

0

-1

-2

0

l

2 

100 

75 

75 

250 

50 

75 

75 

75 
100 

375 

100 

75 
100 

50 

50 

375 

1000 

100 

Higher level of savings in richer Member States 

75 

0 

No obvious inequities 

May eliminate distortions to allocation of portfolio 
capital but could diven savings 

I

175  I Moderately favourable 

50

75
0

-75

(J 

50 

I

Should not be too costly  to collect 

Revelllles should rise with incomes 

Depends on coverage and rate of the cax 

Will fluctuate with interest-rates 

May be scope for taX avoidance  by investing 
oucside the EU 

I Mix of merits and drawbacks 

I 

I 

-100

Strongly opposed by cenain Member States 

-150

0

Big differences exist  between the Member States 

Not very visible but depends OD the 
implementation of the tax 

50 

Consistent with the ltbcralisation of capital 
movcmcms  and the advent of EMU 
100  More efficiently levied at EU  level 

-100 Could face intransigence from some Member 

States 

125  Might be an option for the long-term 

55 

A European Corporation Tax 

Taxes on highly mobile factors of production such as capital are considered to be most efficiemly levied by 
the  government with the widest jurisdictiop. Within Europe, however, corporation tax is levied By 

individual member states and in some cases regional governments. Tax bases and rates vary across taxing 
authorities.  Attempts have been made to hannonise this tax throughout Europe. but these have met with only 
a limited success. Existing differences  are considered to produce distortions in capital location decisions.  On 
efficiency  grounds.  therefore.  corporation taX has often been considered as a potemial European tax. 
Although such a tax would be best levied at the EU level. the revenues would exceed the current level of 
own resources. so that revenues  would be shared with the Member States. 

Merits 

Drawbacks 

A European corporation tax could provide more than  Although less of a problem than with personal 
enough to meet spending commianems. 

income tax. the lack of a harmonised base constitutes 
a serious problem. 

Because the incidence of company taxes may be 
borne by consumers and investors in other Member 
States, reveoues from such taxes are best assigned to 
the EU. 

The fact that some Member States have an integrated 
corporate and personal income tax system is also 
problematic. 

An EU Corporation Tax would overcome problems 
arising from transfer pricing and other devices 
whereby multinationals shift profits to centres where 
taxes are lowest. 

There is a relative lack of visibility with Corporation 
Tax which means that the objective of accoumabilitv 
is not so well attained. 

Such a tax would  lessen the distortions to economic 
efficiency arising from differem systems of company 
taxation and the costs arising from intra-state tax 
competition. 

It would strengthen the Single Market. 

Since profits fluctuate with the business cycle. the 
revenues from such tax would be unstable. 

Political and Administrative Factors 

Administrative problems could be minimised by continuing the practice of tax collection by Member States. 
However. fundamental differences  exist  between Member States on just how corporate income should be 
treated.  which will make agreemem on the right system to adopt difficult to achieve. The past experience of 
EU attempts to harmonise such taxes do not augur well. 

Assessment 

Quantitative scoring.......................................................................................  Medium 

Obstacles to introduction............................ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 

Strong 

Verdict ......................................................................................................... . 

Fairly 
weak 
(at 
present) 

56 

Criteria 

ECONOMIC 

Equity between Member States 

Fairness between individuals 

Economic efficiency 

.. 

I

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Harmonised tax base 

Visibility and accoumability 

Link to common policies 

Consistency with subsidiarity 

I

Sub-total 

OVERALL 

Corporation tax 

Weight 

Rating 

Score 

Comments 

I 

I 

1 

1 

2 

2 

1 

2 

-1

0 

-1

-2

-1

2 

l

JOO 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

so 

so 

375 

1000 

I

I

I

100 

75 

150 

Should be related to ability to pay 

No obvious inequities 

Strong economic arguments for an EU-wide cax to 
lessen market distonions 

I

325  I Strong on economic criteria 

100 

75 

ISO 

-75 

0

250

I

Can be collected through the Member States with 
no extra cost 

Assuming a stable ratio of profits to GNP 

Capable of yielding revenues  well in excess of 
currem EU  needs 

Likely to fluctuate with the  business cycle 

Broadly neutral 

I Potentially attractive 

I 

I 

-100 Likely to be opposed by most Member States 
because of link with personal income taxation 

-150

Less of a problem than income tax but still 
presents serious difficulties 

-100 Likely to be panly passed on to consumers 

without them knowing 

100 

50

-200

375 

Provides a good linkage with the Single Market 
and attempts to achieve a European Company 
Statute 

Problems in identifying  sources  of profits justify 
tax at the EU level 

I Too many negatives at  present  .... 

... but could be much stronger if moves 
towards harmonisation bear fruit 

I 

I 

I

57 

Modulated Value Added Tax 

VAT bas been contributing to the Community's own resources since 1980. and bas, in the past, been the 
preferred option of the European Parliament as the third own resource. However, VAT has been declining 
relative to the GNP resource as a result of successive legislation, which has both capped the VAT base and 
reduced the VAT rate to be applied. Moreover, the link between the VAT call-up rate and the VAT paid by 
the individual taxpayer has become increasingly tenuous. It would be possible to reform the method of 
assessing VAT at the Member State level and return to the original objective of assigning a proportion of 
VAT to the EU, possibly with a split rate for necessities and luxuries. 

Merits 

Drawbacks 

The tax is reasonably buoyam, revenues increasing 
with private consumption spending and int1ation 

VAT reveD11es are politically comollable because 
any shortage of resources can be easily corrected by 
raising the rate accruing to the EU 

Because the tax is already in place as an own 
resource. it is well-known and familiar to the 
taxpayer. 

VAT could be presemed to provide a clear link 
between what citizens pay in taxes and what is spent 
on the provision of public goods and services at the 
EU level. 

The EU is making progress cowards agreeing a 
harmonised tax base. 

It is sometimes argued that VAT payments do not 
bear a close relationship to a Member State's ability 
to pay, although the evidence suggests that it is not 
as regressive as is sometimes claimed. 

In its current form, the tax is not very visible to 
European citizens and the Member States seem 
reluctant to change the method of assessmem. 

The tax is also probably  regressive at the individual 
household level and may therefore be seen by 
taxpayers to be untair. 

Political and Administrative factors 

Member States have been reluctant in the past to acquiesce to the more visible 'returns' method of 
establishing the tax base, primarily because of the changes that would have to be brought in at the national 
level. If this method cannot be established then much of the benefit of this tax as a distinctive European tax 
is lost. 

Assessment 

Quantitative scoring.......................................................................................  High 

Obstacles to imroduction........................................................................ . . . . . . .  Medium 

Verdict .•....•••.....•....••.•.•••...••.••••••••••.•.•.•.•••..••.•••.•••••••.•...•...••••.•••••••••••••••••••••.. 

Strong 

58 

Criteria 

ECONOMIC 

Equity between Member States 

Fairness  between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue  sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Harmonised tax base 

Visibility and accoumability 

Link  to common policies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

I

Modulated  VAT 

Weight 

Rating 

Score 

Commems 

100 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

50 

50 

375 

I 

0 

1 

2 

I 
2 

1 

0 

2 

1 

I 

1 

0 

I 

I

100 

0 

75 

Good if paymentS made subject  to a GNP-based 
adjusanenc 

Tax may be slightly regressive  at  the individual 
level depending on  the tax base 

Should increase  the  efficiency of the Single 
Market 

175  Moderately favourable 

Cheap  to  collect  as already levied  by  Member 
States 

Should grow  roughly in line  with GNP 

Revenue can be  increased by  raising the rate 

Private consumption speDding is  subject to some 
cyclical fluctuation 

100 

75 

150 

75 

0 

400  Good on these criteria 

Most likely to be  acceptable to Member States as 
VAT already used as  3rd resource 

Likely  to be l"nham:cd as pan of Action PlJJn for 
the Single Market 

Could be highly  visible  but  depends on how it  is 
presented on invoices 

Linkage with the Single Market 

200 

75 

100 

50 

0 

Neutral 

425  I Key advantage is its familiarity 

I 

1000 

1,000  Already approved by EP in Langes Report 

59 

Environmental/Energy Tax 

Criteria 

ECONOMIC 

- X
ECO ta 

Weight 

Rating 

Score 

Comments 

Proposals for a European energy taX have been essemially aimed at reducing carbon dioxide emissions.
However.  as early as 1978. such a cax was considered as a possible source of new revenue for the
Community. In 1992. the Commission proposed a two-stage levy of $10 on each barrel of oil equivalent to
fall on the fuel content of all non-renewable energy plus nuclear energy and half of its carbon comem. This
could most easily be imposed on producers (although this would imply an uneven incidence), or on
consumers. It was estimated that this would generate revenues of approximately 1.1 %  of European GDP.
An alternative might be taxes on petrol and diesel.

Merits 

Drawbacks 

This tax. would provide enough revenue to meet 
existing EU funding requiremems. 

Revenue might fall over time if consumption patterns 
changed in line with the tax's desired effect. 

It would play a useful role in achieving the EU's 
stated aim of reducing cart,on dioxide emissions 

A tax levied by the EU tier would be better than 
action by  individual Member States, particularly in 
reducing the potential for 'free riding'. 

An EU eco-cax would overcome the problem of 
'regional arbitrariness'  in revenue allocation arising 
from a tax applied at the Member Swe  level. 

The tax. would have an educational value in 
discouraging  over-consumption of forms of energy 
which are damaging to the  environment 

The tax would  be unfilir.  with poorer Member  Swes 
contributing most. This is less of a problem for 
petrol we. 

Because preferences with regard to environmental 
standards differ between Member States, it may be 
considered  better that Member States be left free to 
determine the appropriate rate of such tax for 
themselves. 

Political and Administrative factors 

There is no existing base for a carbon tax so that. the EU would be the sole tax. authority. However, there 
would be  initial start-up costs which would need to be considered. By conaast. most Member States impose 
fuel excises,  so there would be much less of a problem for these. The political obstacles are. nevenheless, 
illustrated by the failures to adopt previous Commission proposals. 

Assessment 

Quantitative scoring.......................................................................................  Average

Obstacles to introduction................. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Relatively minor 

Verdict .........................•.......•.......•...............................•..•..........•.............•.... 

Medium 

Equity between Member States 

100 

Fairness  between individuals 

75 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

:i 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

I 

Sub total 

POLITICAL 

I

75 

250 

50 

75 

75 

75 

100 

375 

0 

-1

1 

l

-2

2 

0 

1 

0 

-75

75 

0 

50

-150

Although a petroleum taX would related 
to ability to pay,  this is less likely for a 
carbon tax. 

Except for petroleum rax. it may tend to 
discriminate against the poor. depending 
on the tax base 

Positive effects 

Stronger for coDSU1Der than producer 

Should be relatively cheap to collect 

If it modifies behaviour revenues may 
fall with economic growth 

150 

Could provide sizeable revenues 

0 

Neutral 

100 

Should be minimal if collected mainly 
from large companies 

I 

I

1S0  I Relatively favourable 

I 

0 

0 

l

2 

1 

Member State sensitivities 

100 

Hannonised tax base 

Visibility and accountability 

Link to common policies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

75 

100 

50 

50 

375 

1000 

0 

0 

100

100

50 

250 

May meet some resistance from Member 
States but depends on form and wider 
political climate 

Not at presem. but attempts being made 
to achieve this for some produces 

Could be played up 

Good linkage with enviromnem policy 
and the Single Market 

Good efficiency argumems exist for 
levying chis at the Member State level 

Depends on general sentiment about 
environmental issues 

400  Has potential in longer  term,  but will 

need political commitment 

60 

61 

Criteria 

ECONOMIC 

Equity between Member States 

Fairness between individuals 

Economic  efficiency 

Sub-total 

ADMINISTRATIVE 

: �  Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAi. 

Member State sensitivities 

I

Harmonised r.ax base 

Visibility and accountability 

Link to common policies 

Consistency with subsidiarity 

Sub-total 

ECO-tax 

Weight 

Rating 

Score 

Comments 

100 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

50 

50 

375 

0 

-1

1 

1 

-2

2 
0 

1 

0 

-75

75 

0 

50 

-150

150 
0 

100 

Although a petroleum taX would related 
to ability to pay, this is less likely for a 
carbon r.ax 

Except for petroleum rax,  it may tend to 
discriminate against the poor. depending 
on the tax base 

Positive effects 

Stronger for coDSUD1er than producer 

Should be relatively cheap to collect 

If it modifies behaviour revenues may 
fall with economic growth 

Could provide sizeable revenues 

Neutral 

Should be minimal if collected mainly 
from large companies 

I 

I

150  I Relatively favourable 

I 

0 

0 

1 

2 

1 

0 

0 

100 

100 

50 

May meet some resistance from Member 
States but depends on form and wider 
political climate 

Not at presem. but attemprs being made 
to  achieve this for some products 

Could be played up 

Good linkage with environmem policy 
and the Single Market 

Good efficiency arguments exist for 
levying this at the Member State level 

250  Depends on general sentiment about 

environmental issues 

OVERALL 

1000 

400  Has potential in longer  term, but will 

need political commitment 

61 

Alcohol and Tobacco Excises 

Excise duties  on alcohol and tobacco  are curremly levied at varying rates in all Member States. A degree of 
harmonisation has. however. takeit place. For example, a minimum taX rate of 57 %  of the retail price of 
cigarettes was agreed in 1991. This has reduced the potemial for taX competition  as a response to  cross 
border shopping. A share of the revenue already collected  on such taXes by  the Member States is the most 
likely method of using this taX as  a European own resource. 

Merits 

Drawbacks 

This taX should provide  substantial funds as an 
additional own resource  (possibly as  much as 0.6% 
of GDP if  the taX were shared equally between the 
EU and the Member States). 

Because consumption varies little as  taXes are 
increased,  the tax would provide a stable source  of 
revenue. 

The costs of introducing such a tax would be small 
as  the revenue is already collected by the Member 
States. 

The taX would have an educational  value by 
discouraging spending on  'demerit goods'  which 
create social costs. 

Consumption of these goods does not rise in line 
with  income and therefore this taX as a proportion  of 
GDP will  decline over  time unless  rates  are adjusted. 

Consumption of these goods is  negatively correlated 
to per capita income so that this tax would be 
regressive. 

Inequities between Member States will result 
because of differem levels of spending on  alcohol 
and tobacco relative to income. 

Political and Administrative Factors 

There would be few  administrative or political problems  in introducing  such a tax, so long as it did not 
require tax harmonisation.  In the past, this issue has been problematic. with Member States resisting the 
Commission's attempts at harmonisation. 

Assessment 

Quantitative scoring.......................................................................................  Average 

Obstacles to introduction .. �............................................................................  Minor 

Verdict .....................•.....•...............................•............................•................. 

Medium 

62 

Criteria 

ECONOMIC 

Equity between Member States 

Fairness between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stabiliry of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Harmonised tax base 

Visibility and accountability 

Link to common p olicies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

Alcohol and tobacco excises 

Weight 

Rating 

Score 

Comments 

-100 Will hit some  less-favoured Member States 

e.g. Greece and Spain

-75

75 

Regressive tax 

Reduces consumption of social 'bads' and 
would diminish cross-border distortions 

-100

Incidence too uneven to be acceptable 

50 

75

150 

75 

100 

450 

0 

-75

100

50

0

75

I

I

Already exists and should therefore be cheap 
to collect 

Rate can be indexed to intlation and demand 
is inelastic 

Capable of providing substantial revenues 

Spending fairly stable 

Unlikely to be large-scale fraud or evasion., 
but subject to smuggling 

I Familiar taxes with administrative merits 

I 

Neun-al 

Not yet achieved although progress is taking 
place 

Highly visible to smokers and drinkers, but 
less so to other consumers 

Linkage with Single Market 

Neun-al 

I No significant political obstacles 

I 

425 

Attractive administratively, but offset by 
adverse economic characteristics 

100 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

50 

50 

375 

1000 

I

I

I 

I 

-1

-1

1

1 

l

2 

1 

1 

0 

-1

l

l

0 

63 

Using Seigniorage Revenues 

Seigniorage revenues represent the profit that central banks earn on the government debt they hold. These 
profits exist because the liabilities that offset these assets are the domestic bank notes that the central banks 
issue on which  no interest is paid and commercial banks deposits with central banks. In periods of high 
inflation. seigniorage revenues increase nominally as the monetary base expands. The arrival of EMU and 
the creation of a European Central Bank make the pooling of these revenues at the EU tier a real possibility. 
Some estimates suggest that these revenues could amount to 0.4 %  of EU GDP. 

Merits 

Drawbacks 

With a single currency it is harder to apponion these 
revenues fairly to national central banks. 

Because seigniorage revenues accrue from a 
common policy of the EU, it might be considered 
more appropriate that these revenues should belong 
to the EU and not the Member States 

Unlike other taxes, reveIDJes would be vinually 
costless to collect. 

Of all the taxes  under consideration, this  would be 
the least susceptible to fraud 

Because the tax is an implicit one.  it may be 
politically easier for Member State governmerus to 
agree. 

Under circumstances where not all the Member 
States joined the single currency, it might be 
considered unacceptable to these Member States that 
they should make such paymems. 

The tax might also give rise to horizontal inequities 
as countries with higher ini1ation rates ( often the 
poorer ones) would end up paying more. 

The we is entirely invisible to the individual 
taxpayer and therefore fails to meet the objective of 
enhancing accountability. 

The revenue would be relatively small so this could 
only serve as an addition to existing own resources. 

Revenues might also prove degressive if the 
imroduction of a single currency results in more 
cashless transactions and a reduction in the cash 
holdings of the public. 

Political and Administrative Factors 

Perhaps. the main political objection to this proposal is that assigning seigniorage revenues to the EU  would 
require a treary change, as these revenues currently belong to national central banks. On the administrative 
from, however, such a tax.would clearly be cheap to collect. 

Assessment 

Quantitative scoring.......................................................................................  Low 

Obstacles to introduction............................................. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 

Significant 

Verdict.......................................................................................................... 

Poor 

64 

Criteria 

ECONOMIC 

Seigniorage -

Weight 

Rating 

Score 

Comments 

-100

Poor correlation with ability to pay 
because intlation rates differ, but could 
improve 

0 

Neutral 

150 

Discourages high inflation 

I

I

50 

100 

-150

-75

-75

200 

0 

-200

150 

-200

100

I 

I 

I Marginally  positive 

Zero 

Revenues may fall if EMU results in lower 
intlation and reduced cash holdings 

Will provide small revenues only - no 
more than 0.4%  of EU GNP 

Likely to tluctuate with rate of intlation 

No risk of fraud or evasion 

I Mix of good  and bad  features 

Treaty change needed to reassign profits 
from national central banks to the EU 

Is identical in all Member States 

Difficult concept to explain to citizens 

Directly linked to EMU 

100 The method for apponioning these 

revenues to Member States is arbitrary 

-50

0 

Very good on some  criteria, poor on 
others 

Could be worthwhile  if combined with 
other own resources. but not on  its own 

Equity between Member States 

100 

I

I

Fairness between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

Member State sensitivities 

Hannonised tax base 

Visibility and accountability 

Link to common policies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

I

I

I 

I 

75 

75 

250 

50 

75 

75 

75 

100 

375 

100 

75 

100 

50 

50 

375 

1000 

-1

0 

2 

2 

-2

-1

-1

2

-2

2 
-2

2

2

65 

Communications Taxes 

Travel and telecommunications are segmencs of economic activity which have grown steadily and which 
bear a reasonably close relationship to GDP. As trans-European networks are enhanced and with the 
regulatory framework set at EU level, an increasingly close association with EU policies can be discerned in 
·communications'. For these reasons. air transpon and telecommunications services, possibly vehicles too,
might all serve as we bases for own resources.

Merits 

Drawbacks 

Buoyant source of revenue with scope for covering 
all currem expenditure if sufficiently widely cast. 

Might be ponrayed as contrary to spirit of free 
movement in the single market. 

Direct incidence on both consumers and business. 

Positive association with ability to pay and low 
initial cost to candidate coumries from central and 
eastern Europe. 

V chicle taxes could penalise peripheral or rural 
areas. 

Would appear to citizens as a string of taxes. 

Visible connection with EU policies and 
comparatively easy to collect. 

Political and  Administrative factors 

Should be relatively straightforward to imroduce. Airpon taxes and vehicle excises are already collected by 
Member States, although some harmonisation would be required. An imposition on telephony would be a 
new taX. but should be easy to collect. Could be criticised for requiring multiple taxes. 

Assessment 

Quantitative scoring ..... · .................................................................................... High 

Obstacles to introduction.................................................................................  Moderate 

Verdict ........................................................................................................... . 

Good 
candida 
te 

66 

Communication taxes 

Weight  Rating 

Score 

Comments 

100 

75 

0 

Poim of depanure may not reflect the 
residence of the traveller 

Likely to be reasonably progressive 

Neutral 

175  Would fall less heavily on prospective 

new Member States 

50 

150 

75 

75 

100 

4S0 

-100

75 
200 

0 

0 

175 

800 

Should be relatively low; but could 
necessitate scan-up costs 

Spending like to rise rapidly with per 
capita incomes 

Capable of providing sizeable revenues 

Revenues should be subject to only minor 
fluctuations 

Fairly difficult to evade 

Strong contender on these criteria 

Involves new taxes; road transport charge 
could be resisted by some  Member  States 

Either exists or could be achieved readily 

Can be made highly visible 

Limited. but growing, ,e.g. EU regulation 
of telecommunications and air transport 

Neutral 

Positive points;  obstacles not insuperable 

Offers the EP the opportunity to put 
fon-ard  an  innovative solution 

Criteria 

ECONOMIC 

Equity between Member States 

Fairness between individuals 

Economic efficiency 

Sub-total 

ADMINISTRATIVE 

Collection cost 

Fiscal buoyancy 

Revenue sufficiency 

Stability of source 

Susceptibility to fraud/evasion 

Sub total 

POLITICAL 

1 

1 

0 

1 

2 

1 

1 

1 

100 

75 

75 

250 

50 

75 

75 

75 

100 

375 

Member State sensitivities 

100 

-1

Harmonised tax base 

Visibility and accountability 

LiDk to common policies 

Consistency with subsidiarity 

Sub-total 

OVERALL 

1 

2 

0 

0 

75 

100 

50 

50 

375 

1000 

67 

7  Conclusions and recommendations 

7.1  At the risk of stating the obvious, there is no ideal system for financing the EU,  nor is it 
helpful to maintain that there could be. There are simply too many competing interests, 
policy aims and political chojces in elaborating any tax system. Finding a way forward is, 
therefore, a matter of balancing these interests by establishing a system that has as many 
desirable characteristics and as few adverse ones as possible. 

7.2  Nor should the power of inertia be under-estimated. The fact that the system for financing 
the  EU,  by  and  large,  works  and  is  seen  to  be  tolerably  fair  makes  it  difficult  to 
countenance changing from the status quo. There is a widespread belief that the scope for 
changing the system is virtually non-existent.  In our consultations,  the word  'taboo'  came 
up  several  times.  There  is,  nevertheless,  a  disposition  in  some  quarters  to  be  more 
imaginative, and the observations in this section reflect this. 

7.3  The European Parliament is in the curious position of having authority over the spending 
of public money,  but not for raising taxes - taking a cue from the founding fathers of the 
US,  'representation without taxation' is the phrase that has been used. Moving to  a position 
where  it  has co-decision on the means of raising revenue would,  however,  represent a 
significant shift in the institutional landscape of the EU. Moreover,  any such change would 
go well beyond a recasting of the system of own resources. 

7.4  Achieving  transparency  in  budgetary  matters  is  also  a  key  aim  for  the  EP.  For  own 
resources to be visible to citizens, they have to see that there is a direct link between the 
t.ax instruments used and what the EU. This could shine a light on areas that many would 
prefer to leave in darkness, but it can also be argued that this would allow some  of the 
myths about the scale of EU spending to be more easily dispelled.  For the EP,  the Langes 
report remains a valuable starting-point as a way forward for the system of own resources. 
It  advances proposals that would greatly increase the visibility  of EU financing without 
moving too far from the present arrangements. Such a system.  with some tinkering,  could 
serve well over the lifetime of the next financial perspective (2000-06). 

7. 5  However, reform of Union financing also has to be seen in a long-term context. The more
deeply integrated (post-EMU) and enlarged EU anticipated ten years from now will need 
a  system  of  financing  commensurate  with  its  status.  This  should  have  the  following 
characteristics: 

• It should have resources that it can genuinely call its own, such that the spirit as well
as the letter of Article 201 is observed. This means assigning sufficient tax instruments
to the EU to allow it to raise all the revenue it requires  from identified taxes,  rather
than a transfer from Member States based on a GNP key.

• The taxes so assigned should have the property that, between them. they assure a stable

and buoyant flow of revenue that fully funds the budget.

• As  far as possible,  any resource  chosen  should  have a link  to EU policies.  thereby
emulating agricultural and customs duties.  We recognise that there will be differences

68 

of perception,  and thus opinion, on what constitutes such a link, but still put it forward 
as a desirable property. 

• The  system  should,  at  the  outset,  be  designed  to  assure  an  equitable  burden  on
taxpayers,  both  as  between  Member  States  and  across  social  groups.  It  should  be
recognised that taxes waich cannot easily  be assigned  to  Member States complicate,
and may render invalid,  the calculation of relative contributions.

• If,  however,  circumstances change such  that  contributions become inequitable,  then
some  form  of  equalisation  should  be  introduced,  possibly  a  variant  of  the
jinanzausgleich that assures this in Germany.  A per capita GNP key,  using purchasing
power exchange rates,  is the obvious mechanism for this.

• It is, nevertheless, important to distinguish between inequities in  contributions and the
inevitable demands for juste  retour.  Such demands would be diminished if the pattern
of expenditure did not so greatly distort equity achieved on the revenue side.  Ideas for
dealing with this problem are outside the scope of the present study, but could be the
subject of another.

Suggested way forward 

7.6  With  these  principles  and  aims  in  mind,  we  advocate  an  evolutionary  approach to  the 
development of the system of own  resources.  In recognition of the political constraints, 
ambitions for what can be achieved between 2000 and 2006 have to be limited. Equally, 
it  is  reasonable to assume  that some key  steps  in  European construction  will have been 
taken by then.  Unless there is a sea-change,  EMU will be a reality.  At least some of the 
proposals in the Commission's  1997 Action  Plan for the Single Market will have come to 
fruition,  notably in  the fields of harmonisation  of  VAT and of corporate taxation.  The 
probable accession of several new Member States will, in addition,  provide the opportunity 
for (indeed,  necessitate) institutional reform so that Treaty  revisions  will occur. 

7.7 

In the short term, the aim should be to establish (or,  perhaps, re-establish)  true ownership 
of resources by the EU. To this end,  a first element of a solution is to adopt the proposals 
in  the  Langes  Report,  namely  to  put  in  place  a  modulated  VAT  resource  that  is 
administered in a manner visible to the citizen.  This instrument obtains a favourable rating 
on our assessments and has the added advantage of familiarity. Consequently, the political 
obstacles  are  likely  to  be  lesser  than  if  a  more  radical  change  were  to  be  sought. 
Appropriately modulated VAT should, moreover.  assure a reasonably equitable distribution 
of the fiscal burden between  Member States,  always a tricky political factor. 

7. 8  To complement modulated VAT and to reinforce the principle of ownership of resources,
we funher recommend adding a complementary resource. Two of the taxes reviewed above 
seem the likeliest candidates for this role. 

7. 9  The first would be to assign the proceeds of seigniorage accruing to the ESCB under EMU,
given that there is a very obvious connection  with EU  policies and that is bound to be 
difficult accurately to  assign  these  revenues  by  Member State.  If the estimates  quoted 

69 

above are accurate, this could raise up to a quarter of the budget.  The drawbacks with this 
are  that  it  would  need  a  Treaty  change,  uncertainty  over  the  revenue  stream  and  the 
probability that  not  all the Member States will be full participants in EMU.  The last of 
these need not preclude  assigning seigniorage to the EU. as the national central banks in 
question would still obtain such a revenue stream, but the politics would inevitably be more 
awkward. 

7. 10  On  balance, 

therefore,  we  prefer 

the
'communications'  taxes  described above.  Assigning the  proceeds  from airport departure 
taxes (yielding just short of 10%  of the budget if set at 15 ECUs) would seem warranted 
because of  the  buoyancy of the revenue,  the growing  'Europeanisation'  of air transport 
policy and the other relatively favourable attributes of the tax. 

the  option  of  introducing  elements  of 

7 .11 Depending on how much revenue was needed, serious consideration should also be given 
to the introduction of a tax on telephony as a second element of the 'communications'  tax. 
Whether this is ad valorem or a specific tax on lines is a matter for detailed negotiation, 
as would be the rates to charge to different classes of users (mobile,  business,  domestic). 
As a new tax, it would inevitably encounter resistance,  but could again raise around 10 % 
of the budget with a modest average annual tax of 40 ECUs per phone line. 

7.12 The proposed package for 2000-2006 would,  therefore,  have four or five resources: 

• The rwo traditional own resources,  accounting for a share falling off from its current

17 %  to perhaps 10 %

• A modulated VAT  resource providing the bulk of the revenue

• One or two 'communications' resources making up the difference, while also providing

the buoyancy to offset the decline of the first two.

Longer-term developments 

7 .13  Much can  change in  the  ten years leading up to the next but one financial perspective. 
Major  shifts  of  opinion  could  occur  globally  in  relation  to  environmental  protection, 
making an eco-tax much more attractive.  Within  the EU, significant changes in corporate 
law could  be  introduced in a way which  made  a pan-European  corporate tax a feasible 
option.  The  MacDougall Report blueprint for the supranational  budget could well have 
swung back into favour. 

7 .14 Our proposal for the second half of the next decade is that one or other of these major taxes 
should be assigned primarily to the EU level,  but with a mechanism for redistributing any 
surplus to Member States as the principal means of ensuring proportionality. 

7 .15  If the eco-tax were adopted. it should be arranged so as to achieve adequate buoyancy and 
to  have a  wide and  reasonably harmonised base.  This would argue for it to be aimed at 
consumers rather than producers. and might be achieved simply by focusing on petrol and 
diesel duties. 

70 

7.16 All  these longer-term options would require a more radical overhaul  of the system with 

planning starting early in the next decade. It would end with 

• What remains of the revenue from the two traditional own resources and the proposed

• The main income  flow c(1ming  from either corporation taX or a sensibly configured

eco-taX.

• Continued use  of the  'communication'  taxes,  provided that  they  were seen to have

functioned well.

• A robustfinanzausgleich system to ensure ex-post equalisation.

7 .17 If none of the above  is acceptable,  we understand that Commissioner  Liikanen has been 

approached at least once by a lottery operator  ... 

71 

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�bility-to-pay is a principle of taxation which states that the burden of taxation should fall most heavily 
on the shoulders of those best able to bear it. This favours a progressive system of taxation 
whereby 
higher income earners pay proportionately more of their income in tax than low income earners.

pricing 

will 

public 

higher 

sectors 

against 

terms of 

marginal 

and 
the 

as 
cost 

citizens 
in 

Benefit 
is a term used in tax theory to refer to the principle of ensuring, as far as possible, that 
(hose who benefit from the provision of a particular public good or service also bear the cost in the fonn 
of taxes levied to finance spending. It is argued that this will ensure a better allocation of resources as 
to weigh the marginal benefit from increased 
be able 
een private 
tw
be
e
nding 
t
n""essive taxes are taxes the revenue from which tends to decline over time as a proponion of national 
..,me. Taxes which seek to deter undesirable economic behaviour (e.g. pollution taxes) may possess 
taxes problematic as sources of 

mis attribute to the extent that the tax is effective. This makes such 
1evenue even if other economic arguments support their imposition.
fconomic  efficiency  is  achieved when  productive  resources  (land,  labour,  capital,  etc)  have  been 
ulocated  as  between alternative activities in a way which maximises economic welfare. The latter is 
attained  when it is no longer  possible to make any one better off without at the same time  making 
10meone else worse off (so-called Pareto optimality). 

taxes. 

2.�,�c::s \-..;th cdcntical eircwnstan.CC$ the smi.e For example. eva;·one should pay the same proportion 
« m:lr incomes. in wcadon  An ah.em.a.rive ince:preiition - • ven,� eiqu1 ry • - mies chat ta>CCS should be 
:cta1Q to lhc ability of a person (0  pay  Taxpaycn with greuer muns should pay proportionately more 
..'l ta.x th1t1 I.hose of lesser m,ea.ns. 

£xu,noliti1::s �sa or benefits on timu or indiv1dWJ other than lhosc bcanng the eosc or buy1ns the 
ood  As such.  they do not enter into lhe  cost calculanons of firms or pnce decisions of con.svmcrs 
t·o1e.ss :id;ustcd for duo\lgh the we system. they may result in, dinon,on tt) the aJJocanon of rcs.o1.trces 
?.uhin the economy 

riJcal �u�yancy  �s attained  whcm the revenuc::s from tax increase with economic growth withoin the 
!Ce:SSl1)' 10 i.ocreasc the rate oftax  For example. revenues from income u:  tend to be buoyant becau.st 
f Ckn<>"-n as· fisc.a! drag•) : revenues increase with ancrcased nomtml incomes without mny change an 
�x  , res  By coons� mxcs which effecrive!y derer certain fonns of tconomrc  behaviour (e g  polluoon 
li.'<es) may res ult in declining revenues 

Fiscal federalism as concerned with how different types of g,ovemmen, spendins and different taxes 
ln.ou!(!  be allocated  betwtto  titn of governmen.t in a federal economie ,ys1cm  Jc  seeks to expound 

74 

75

 
 
certain economic principles which might guide the assignment of government functions and taxes to the 
various layers of governance which exist within such a system. 

A Harmonised tax base exists when prospective tax payers in different jurisdictions are subject to the 
same tax rates and rules. This means that the tax should be levied on the same individuals in all countries 
and tax rules regarding matters such as special exemptions, tax asessment, etc should be the same.  Such 
a  base  clearly does not  exist for most  direct  taxes within the EU.  On the  other  hand,  considerable 
progress has been made in harmonising the tax base for indirect taxes within the EU. 

'Owned taxes' are taxes which are assigned explicitly to a level of government, and are favoured to the 
extent  that  they  provide  a  link  between  the  electorate  and  the  decisions  taken  by  that  level  of 
government. 

Pareto optimality is the most widely used notion of efficiency in economics in that it defines a situation 
in which economic welfare is maximised. This corresponds to a point where it is not possible by shifting 
resources from one activity to another to make one person better off without at the same time making 
another person worse off. 

Portfolio investment is the term used by economists to refer to overseas investment which takes the form 
of  the  purchase of  interest-bearing financial assets such as shares or government bonds.  This is is 
distinct from direct invesnnent which involves companies acquiring productive assets in another country 
either through the establishment of an overseas subsidiary or though the purchase of a controlling interest 
in a foreign company. 

Progressive taxes are taxes which bear more heavily on those with higher incomes and therefore greater 
ability  to  pay.  This  is  because  the  rate  of  tax  increases  with  the  level  of  income.  They  may  be 
distinguished from proportional taxes where the rate is the same at all levels of income although higher 
income taxpayers still pay more tax measured in absilute terms. 

Purchasing power parity involves the use of exchange-rates such that the prices of identical goods and 
services are equalised in different countries. The exchange-rate which achieves such an equalisation need 
not correspond to the market exchange-rate but is often more appropriate to use in comparing the values 
of economic aggregates such as GDP or GNP internationally. 

Regressive taxes are the opposite of progressive taxes in that they extract a higher share of income from 
less well-off tax payers than from richer ones. 

Revenue  arbitrariness  arises where  the  distribution  of  revenues  from  a  particular  tax  as  between 
different tax jurisdictions is not governed by any economic logic but is the outcome of largely accidental 
factors.  One of  the  best  examples of this is the so-called  'Rotterdam-Antwerp effect'  in  respect of 
customs duties collected by the EU: because a disproportionate share of EU imports from third countries 
enter the EU through the ports of Rotterdam and Antwerp, the Netherlands and Belgium account for a 
relatively large amount of the revenues collected. 

76 

Revenue  neutrality is  respected  when  a  tax  change  does  not later the  aggreagte  burden of taxation. 
Posiible changes in own resoureces will be revenue neutral if they leave the total EU budget unchanged 
as a proponion of EU GNP. 

Subsidiarity is a principle expounded in the Treaty of European Union (the Maastricht Treaty) of  1992 
which  confines  the  areas  of  exclusively  EU  competence  to  actions  whose  objectives  cannot  be 
sufficiently achieved by the Member States and which are therefore better performed  by the Community. 
It also limits the scope of Community action in such cases to what is required to achieve the objectives 
of the Treaty and no more. 

Thin capitalisation is a term used to the practise of companies financing overseas operations through 
the issue of debt rather than equity in oredr to shift tax liability from high- to low-tax countries. 

Traditional own resources is the term used to refer tothe first two own resources - customs duties and 
agricultural levies - introduced  at the time when the own resources system was  first established.  This 
wass  to  distinguish these  resources  from  value-added  tax  which failed  to  meet  all  the requirements 
generally associated with an own resource. 

Transfer price manipulation occurs when multinational companies fix the prices  of intra-firm sales 
(sales between parent company and affiliate or vice-versa) at levels which diverge from market prices 
i.e.  the  prices  for  equivalent  arms-length  transactions  between  independent  buyers  and  sellers.  By 
over­or under-invoicing sales, multinational companies may avoid taxes, reduce the amount of customs 
duty to be paid on imports, get round exchange-controls or evade controls on the repatriation of profits 
which may undermine the sovereignity of national governments.

Visibility in the realm of taxation means a tax which is known to the taxpayer and where the taxpayer 
is able to determine precisely how much of what he spends or earns that is accruing in tax to the public 
authorities.  Visibility is imponant for  ensuring  accountability in the political  sphere  as between the 
budgetary authority and the voter. 

77 

Annex I 

The Theory of Fiscal Federalism 

Al.I.  There is an extensive and growing literarure on how public finances should be organised in 
a  federation  (e.g.  Musgrave  (1969,  1981),  Oates  (1972,  1991)).  The  concern  of  these 
writings has been with determining whether or not any clear rules can be established with 
regard  to  how  different  forms  of  spending  and  taxation  can  be  apportioned between  the 
differem tiers of governmem in a tederation (tederal, state, regional. local). According to this 
literarure, the appropriate level at which a public service should be provided is determined 
by the geographical distribution of benefits derived from a public good.  Because the costs of 
providing a public service per head of the population fall with the size of the area over which 
the  benefits  are spread,  it is  efficient to supply  public  services  over  as  large an area as 
possible.  However, because preferences for public goods differ  between regions, it is not 
efficiem (in terms of the economic notion of Pareto optimality) to provide these services on 
a uniform basis to all regions.  It follows that different public services are best provided at 
different  layers of government depending on the importance  of these two factors for each 
public good. 

Al .2.  In practice, it is not possible to delineate neatly regions best suited for the provision of each 
public good.  One reason is that actual political boundaries do not necessarily conform with 
boundaries which efficiency considerations dictate. Another reason is that governments tend 
to supply a  bundle of public goods. What might be an appropriate size of region for the 
provision  of  one  type  of public good may not  be for  another.  Thus,  the  theory  of fiscal 
federalism has a rather limited practical usefulness.  It is, however, important in identifying 
differences  in  individual  preferences  as  the  economic  factor  constraining  centralisation. 
Centralisation is only warranted where preferences are homogeneous across regions and the 
costs of public provision fall greatly with the scale of provision. 

Al.3.  Fiscal federalism also focuses on the possibility of externalities or spillover effects in the 
provision of public services.  Certain kinds of public services in  one panicular region may 
bring benefits to individuals in other regions who are not required to contribute to the cost 
of supplying the service in question. This may favour extending the size of the region over 
which a particular public good is supplied to encompass all citizens who derive benefits from 
the  service (see Olson,  1969).  An obvious example  of a public  good  which  gives  rise to 
externalities of this kind is pollution control. Thus, spending by one region to reduce damage 
to the environment caused by, for example, gas emissions is likely to bring benefits to other 
regions in close proximity.  On the other hand. spillover effects  of this kind can be resolved 
in ways which need not entail cenrralisation.  For example,  it would be possible for other 
regions to make horizontal grants or payments to the regions which incur the costs of policy 
measures of this kind. 

Al.4.  The aspect of fiscal federalism which is of most relevance for this report is,  however,  the 
question of how revenue sources should be assigned vertically between the different layers 
of government. The proportion of funds raised from taxation should be distributed to different 
layers  of  government  will depend  on  the  level  of  public  goods  provisions  deemed  most 
efficient  at  each  tier.  However.  that  leaves  open  the  question  of  what  taxes  should  be 
assigned to different levels. One principle set out in the literature on fiscal federalism is that, 
as far as possible, the taxes assigned to a particular layer of government should accord with 
the level of benefits derived from the public services provided by that layer (see Musgrave, 
1983).  The reason for this is  that it  establishes  a visible link  in  the eyes  of the taxpayer 

A-1

between what he/she pays in raxes and the benefits derived from the public services provided 
out of those proceeds. Then. through the ballot box. the taxpayer can vote for more or less 
public services according to whether or not the marginal benefit exceeds or falls short of the 
price paid in the form of taxes. 

Al.5.  There  are  obvious  theoretical  problems  with  this  argument.  For  example,  it  implicitly 
assumes  that  governments  provide  only  one public good  and  that  the  preferences  of  all 
taxpayers for  that  good are identical. However, the major weakness of this approach is that 
it is concerned only with  the revenue effects of taxation (see Spahn,  1993).  That is to say, 
the  sole  objective of taxation  is  implicitly  assumed  to  be raising revenue to  finance  the 
spending incurred at different levels of government as a result of the decisions made about 
the functions of each level. Yet, raxes are imposed for other reasons.  For example, a tax may 
be imposed to correct for a divergence between private and social costs. The question needs 
to be asked  whether it is best for this  tax  to be  levied at  a central or regional  level.  An 
example of this which we consider below is whether a tax on the use of carbon in order to 
reduce gas emissions which are destroying the environment should be imposed at the federal 
or the state level. 

AI.6.  In  the  more  recent  literature  on  fiscal  federalism,  other  consic.er2tions  governing  tax 
assignment  have been  introduced.  In  addition to  the  economic factors already  discussed, 
Spahn (1993) has suggested that two other considerations are also important. First, there is 
the problem of  tax competition.  Taxes on factors which are regionally mobile (e.g.  capital 
and  labour)  will,  if imposed at different rates at the regional level,  induce movements of 
factors from high-tax to low-tax regions. This will invite countries to cut taxes in an effort 
to attract mobile factors to their own territory.  If other countries retaliate by lowering their 
taxes, the result will be a progressive lowering of taxes in all regions leading to a sub-optimal 
provision of public goods in all regions. Leaving aside other considerations, this may create 
an argument for centralising the taxation of labour and capital income at the federal level. 

Al. 7.  Second,  the  revenues from certain kinds  of taxes cannot easily  be assigned to particular 
regions. It is then an arbitrary maner how these revenues are regionally assigned. Within a 
customs  union. the revenues  raised from  the imposition of a common external tariff will 
accrue to those member states through whom goods from the rest of the world are largely 
imported.  (In the EU,  this has come to be  known as the  "Anrwerp-Ronerdam effect").  It 
makes no sense to assign these revenues to the individual states and hence a clear case exists 
for centralisation. As we explain below, in a Single Market, a similar case can be made out 
for centralising the taxation of the profits of multinational enterprises because of the ease with 
which multinationals may shift profits from one country to another. 

Al .8.  Third. there may be economies of scale from collecting and administering certain taxes at the 
central rather than the regional level.  The centralisation of tax collection and administration 
may lower costs through greater specialisation.  On the other hand,  where tax administrators 
are  required  to  handle  a  considerable  amount  of  infonnation  about  local  needs  and 
circumstances,  decentralisation  will  be  more  efficient.  Moreover,  even  if  falling 
administrative costs favours centralisation,  there is no necessary reason why the revenues 
collected should also be assigned to the central level. 

AI.9.  An  important role for taxation in a federal system is to correct for regional  inequities.  If 
particular  taxes  are  assigned  to  individual  regions,  this  is  likely  to  give  rise  to  certain 

A-2

undesirable economic  effects.  Since different regions  will have different levels of taxable 
capacity,  the burden of providing a given level of public  services  will be higher in some 
regions than in others. This means that poorer regions will face either a smaller provision of 
public  goods  or  a  greater  tax  burden.  It" left  uncorrected.  these  inequities  will  result  in 
divergent rates of economic growth and increasing regional inequalities. contrary to the EU's 
cohesion objectives. However, this problem can be tackled either through horizontal regional 
equalisation grants (rich regions making payments to poor regions) or through asymmetrical
vertical grants (richer regions making net paymems to the higher tier, poorer regions enjoying 
net receipts).  One disadvantage of such corrective devices is that they break the link between 
taxation and spending at the different levels of governments which the classical approach to. 
fiscal federalism favours. The alternative would be to  assign taxes to the federal level which 
have a strongly progressive element or to use the expendirure side of the federal budget to 
achieve the same effect. 

Al.IO.  A  weakness of the literature on fiscal  federalism is that it ignores the political dimension. 
Federal systems across the world differ in the extent to which policy-making is centralised 
at  the  federal  as  opposed  to  regional  levels.  Thus,  Australia  and  Canada  stand  out  as 
examples of fairly centralised systems.  At the other extreme,  Switzerland and the United 
States are examples of federations which allow the individual states a high degree of regional 
autanomy. These different arrangements have been shaped by historical development but also 
reflect divergent views about the acceptable degree of centralisation.  It seems likely that, 
because  of the different  languages  and culture  prevalent  within the European  Union,  the 
Member  States  will  end  up  favouring  a  union  closer  in  kind  to  the  second  of the  two 
extremes. This consideration must necessarily determine how, if at all. the theory of fiscal 
federalism is to be applied within the EU. 

A-3

Annex 2  The Historical Background to the Own Resources System 

A2.l.  Articl e  200  of  the  Treaty  of  Rome  provided  for  the  budget  of the  European  Economic 
Community (EEC)  to be �nitially financed by a system of financial contributions from each 
of the six Member States (\vith a separate scale of contributions for the European Social Fund) 
intended to reflect the relative size of the different countries. Thus, Germany, France and Italy 
were each required to provide 28% of the funds, Belgium and th e Netherlands 7.9% each and 
Luxembourg 0.2%. Article 202-3 stated that the size of the budget was to be determined for 
one  financial year by the Council of Ministers acting by a qualified majority on a proposal 
from the Commission and subject to the approval of the European Parliament. Parliament was 
given  the  right  to  make  amendments  to  the  draft  budget  - although  the  Council  could 
subsequently modify amendments - and to reject the entire budget. 

A2.2.  Ho\vever, Article 201  also provided for the  eventual replacement of financial contributions 
,vith a system of financing based on the Cornrnunity·s own resources. Article 201 stated that:-

'The  Commission shall exa.r:.1ine  the  conditions  under  which the  financial 
contributions of Member States provided for in Article 200 could be replaced 
by the Communities' own resources, in particular by revenue accruing from 
the common customs tariff ,vhen it has been finally introduced. 

To  this  end, the  Commission shall submit proposals to the  Council.  After 
consulting the  European  Parliament  on  these  proposals  the  council  may 
acting  unanimously,  lay  down  the  appropriate  provisions,  which  it  shall 
recommend to the Member States for adoption in accordance with respective 
requirements.' 

Only one  element of this system - revenues collected from the common customs tariff -was 
specifically named, the Member States being left to determine what other forms of  revenue 
should constitute parts of own resources.  Nor  was it stated when the change  to a system of 
O\\ln resources should take place. the decision being left to the Council of Ministers acting on 
recommendations from the Commission in consultation with the Parliament. 

A2.3.  By contrast, the spending of the European Coal and Steel Community (ECSC) created by the
Treaty of Paris of 1951  was from its inception financed by a system of own resources. Article 
49 of the Treaty empowered the High Authority to procure funds by imposing levies on the 
production of coal and steel and by contracting loans. The levies could not exceed 1 % unless 
authorised by the Council acting by a two-thirds majority. In  effect, the Member States chose 
to giYe to the High Authority the power to raise taxes to finance spending required for it to 
fulfil its obligations under the Treaty.  From 1957 onwards, the decision regarding the levy 
was in .effect determined b y  the High Authority in association ,vith the Parliament. After the
three  Communities (EEC ECSC and Euratom) were merged in 1967, a separate budget for 
the operating spending of the ECSC was retained which continued to be financed by coal  and 
steel levies. 

A2.4.  The  event  that  first  prompted  the  Commission  to  make  proposals  regarding  own 
resources  was  t he  assignment  in  1962 of  financial responsibility for  the  Common 

A-4

Agricultural Policy (CAP) to the supranational tier. Accordingly,  in March,  1965, the 
Commission sent to the Council of Ministers proposals concerning the financing  of the 
CAP  and  the  provision  of  own  resources,  plus a strengthening of  the power  of  the 
European  Parliament.  However.  these  failed to  secure the agreement of the Member 
States. Agreement was further postponed by the crisis of the "empty chair" lasting from 
June  1965 to January 1966 such that it was another five years before the Heads of State 
were ready to make a final decision. 

The Luxembourg Agreement (1970) 

A2.5.  The  provisions  for  a  system  of  own  resources  were  contained  in  the  now-famous 
Luxembourg Agreement  of 21-22 April,  1970. The Agreement was subsequently ratified 
by the Member States according to what their various constitutions required and came 
into force at the beginning of 1971. This  followed  the Council of Ministers' Regulation 
2/71 of  2  January  I 971 providing  for the  transfer  of 
the  ownership  of  certain  tax 
revenues from the Member States to the Community. The Luxembourg Agreement stated 
that the own resources of the Community should be drawn from three sources:-

•

•

•

Agricultural and sugar levies imposed under the Common  Agricultural  Policy
on imports from non-member countries.

Customs duties collected from the operation of the Common Customs Tariff on
imports from non-member countries.

A  p ercentage (not greater than  1%) of  Value-Added Tax (VAT) applied  to a
uniform assessment base.

The first two resources were known as "traditional own resources" to distinguish them 
from VAT. The revenue from agricultural levies was to be transferred immediate! y and 
in full to the Community, while customs duties and VAT revenues were to be assigned 
progressively to the Community over a period of four years. 

A2.6.  With regard to VAT, two Council Directives in 1967  had  required all  the Member 
States to adopt a common system of VAT (67/227 and 67/228, on, 14 April,  1967, No 
71).  However,  it  was  not  until  1977  with  the  passing  of  the  Sixth  Directive  that 
agreement was reached on a uniform basis for assessing VAT (77/388, OJC 17 May 
1977).  Because of the delay in agreeing a uniform basis for assessing VAT,  the third 
resource did not become a full Community resource until 1979. Even then, three Member 
States (Germany, Ireland and Luxembourg) failed to implement the Sixth Directive in 
full. During the transition period leading up to full implementation of the system of own 
resources  in  1980,  the  Member  States  remained  subject  to  a  system  of  financial 
contributions based on G�'P, as did Greece in the early years of its membership. 

A2. 7. 

.A.s a balance to the increased autonomy that the Community gained in budgetary matters 
as a result of the creation of own resources, the Luxembourg Agreement also conferred 
a limited increase in the responsibility for budgetary matters on the European Parliament. 

A-5

These  new powers  were essentially  on the expenditure side  of the  budget,  and  were 
increased  again  by  the  Treaty  of  22  July  1975.  However,  with  respect  to  the 
Community's revenue, proposals  put forward by the Commission on  l O October  1973, 
which would have involved Parliament  in decisions to  change existing levels of revenue 
and raise loans as additional sources of revenue for the Community,  were rejected by the 
Council.  Indeed the Council Decision of the 21 April 1970 remained unchanged until 
budgetary  crises  led  to  the Fontainebleau  agreements  of 25  and  26  June  1984,  that 
resulted in the Council decision of 7 May  1985. 

A2.8.  .-\ key issue in the implementation of the Luxembourg Agreement concerned the method 
to be used to detennine the VAT assessment base. During the transition period ( until  12 
December,  1982),  Member States were free to choose between two methods:-

•

•

The returns or base-on-base  method which, as the name implies, is based on the
actual VAT returns received from taxable persons during a given year

The revenue method whereby the VAT base is determined by dividing the total
net revenue collected by an a'v erage weighted rate representing the VAT rates
applying the Member State concerned.

It was  the intention of the Commission, supported by the Parliament,  that the returns 
method would be adopted by all Member States. However,  this was not acceptable to the 
Council and consequently the Member States were left free to choose.  In fact, during the 
transition  period,  the  majority of the  Member  States  opted  for  the  revenue  method, 
largely on the grounds that it was more compatible with the existing national systems. 
It is by no means clear that the returns method was as complicated as the Member States 
argued. However, what was not in doubt was the fact that only the returns method could 
deliver a visible and direct link between the Community and the taxpayer. 

A2.9.  In the ensuing debate the Commission took a somewhat  pragmatic  line as can be seen 

from its report on the implementation of the VAT Dire.ctive (Regulation 2892/77):-

, .. .in view of the difficulties  which the Member States have invoked in 
support  of their  claim  that  method 
is  unworkable,  particularly  the 
inadequacy of the returns for that purpose,  the use of another method, 
albeit less direct,  is perhaps the only  way of ensuring the payment of 
VAT own resources without further considerable delay.' [COM(85)  170, 
p  18] 

However, the Parliament was dismissive of the practical problems raised by the Member 
States and took a much stronger line on the choices facing the Community as rehearsed 
in the Cornelissen Report (European Parliament,  1985): 

'Can  parliament  tolerate  the  fact  that  revenue  from  VAT  is  being 
increasingly watered down to a national financial contribution following 
the necessary abandonment of the principle of the uniform VAT rate and 

A-6

can  it  accept  that  the  establishment  of  the  uniform  VAT  base  1s 
ultimately reduced to a statistical calculation? 

-Or must every effort be made in connection with the calculation of the
VAT  base  to  revive  the communities'  own  resources  system  and  the
financial autonomy of the Community which is dependent thereupon?'

The Fontainebleau Agreement (1984) 

A2.10. Harmonisation of the procedures relating to VAT was not, however, the only problem 
faced by the own resources system. It also failed to provide sufficient revenues to meet 
the spending commitments entered into by the Community. A major problem was  the 
escalating costs of the agricultural price support policy which absorbed roughly two­
thirds of  the budget.  On the revenue side,  the two traditional resources proved to be 
essentially degressive sources of finance. Although higher agricultural support prices 
relative  to  world prices meant higher variable  levies were collected on food imports 
under the CAP, the effect of higher levies  was to reduce the volume of food imported 
from outside the EC. The revenues accruing from customs duties also tended to fall as 
the Common Customs Tariff was lowered (e.g. as a result of the Tokyo Round of GATT 
which  was  concluded  in  1979)  and  tariff-free  access  was  granted  to  an  increasing 
number of non-member countries which signed preferential trading agreements with the 
EC. At the same time, although VAT revenues rose with inflation and increasing relative 
consumption, the amount which could be collected from this source was fixed by the 
VAT call-up rate of  I%. This could only be raised by the unanimous agreement of all 
the Member  States.  Although only fully implemented in  1980, the system was almost 
immediately in deficit, with expenditure being deferred to future years.  In both  1984 and 
1985, extra funds had to be made available by the Member States when the I% VAT 
ceiling proved inadequate to finance Community appropriations.  Not only were existing 
revenues inadequate to meet the present commitments of the Community, but a need for 
additional revenue to meet new commitments was anticipated. In particular, funds were 
needed to  cover the costs  of the third  enlargement of  the EC (the  entry of  Spain and 
PoitUgal) and of new common policies including the increased use of structural policy. 

A2.11. A further problem was the issue of Britain's net budgetary contribution which turned out 
to  be  larger  than of  any other Member  State under the  newly-established  system of 
financing the Budget.  The reasons for this were: 

•

•

•

•

The predominance of CAP spending in the Budget since agriculture occupied a
relatively small position in the UK economy

The relatively large net UK imports of food from outside the EU

The fact that a relatively high proportion of UK imports of  manufactures came
from countries outside the EU and

The UK's relatively high ratio of private consumption spending to GNP which

A-7

meant that it had large VAT payments to make. 

The British "problem" had been partially anticipated at the time of British entry in 1973. 
As a result,  an assurance was given that if this persisted, a solution would be found.  A 
special safeguard mechanism had been negotiated as part of the Dublin Summit of 1975 
whereby Britain would r�ceive a repayment if her gross contribution became excessive. 
The latter was defined as a contribution in excess of 110% of EC GNP. However, to be 
eligible, the UK's per capita GNP would need to fall below 85% of the EC average and 
the  growth-rate  of its  per  capita  GNP would  need  to  be  less  than  120%  of the EC 
average. 

A2.12. The Dublin Agreement failed to provide the UK with a remedy to its problem because 
the imbalance related to its net not gross contribution. In 1980, the UK net contribution 
was estimated at EUA 1814 million (£1209 million).This situation was unacceptable to 
the  then UK  government,  which  called for a  reform of the· system for financing the 
Budget which would substantially reduce the size of its contribution. In the interim, the 
UK secured the promise of a temporary rebate of its contribution mainly through special 
expenditures in the UK under separate agreements. In May 1980, at Brussels, the UK 
secured a rebate of£ 1570 million over two years which proved sufficient to reduce its 
net contribution to £3 70 million in 1 980 and £440 million in 1981. In 1982, agreement 
was reached for another one-off payment to the UK of £500 million. These ad hoc deals 
were accompanied by much political friction. 

A2.13. The need to provide additional revenues to finance existing commitments and any new 
common policies which the Community wished to develop as well as the need to provide 
some solution to the "British problem" required  a rexamination of the own resources 
system. A simple solution to the revenue problem was to secure the agreement of the 
Member States to raise the VAT ceiling. However, it was by no means assured that the 
Member States would agree to do so. The UK in particular wanted a more permanent 
resolution of its "excessive" net contribution before agreeing to a raising of the VAT 
ceiling, and some assurances on agricultural spending. The latter was achieved by an 
agreement of Farm Ministers in March, 1984, which cut agricultural support prices by 
0.5% (in ECU terms) for the marketing year 1984/5 (although prices still rose in national 
currency terms because of green-rate devaluations) and introduced a system of quotas 
and  guarantee  thresholds  to  control  overproduction.  A system of quotas  for  milk 
production was established, initially for a period of five years, with severe penalties if 
quotas were exceeded, and new guarantee thresholds for crop products introduced price 
cuts for products in oversupply. 

A2.14. A  resolution of the budget problem was secured at a meeting of Heads of State  and 
Government at Fontainebleau on 25-26 of June,  1984. This included changes in the own 
resources, the first since the Luxembourg Agreement of 1970. The main points of the 
Fontainebleau Agreements were: 

•

An increase in the maximum VAT call-up rate from 1 % to l .4% to take effect
from 1 January, 1996. (In 1984 and 1985, extra funds had to be made available

A-8

•

•

•

•

to make good the deficiency in revenues and to meet spending commitments). 

A further possible increase of the maximum VAT rate to  1.6% on  1 January  1988
subject to a unanimous agreement of the European Council. It was envisaged that
the  1.4 % VAT ceiling would prove inadequate to meet future commitments (in
particular,  the accession of  Spain and Portugal) and would therefore need to be 
raised again.  However, this would require the assent of  all the Member States.

A budget adjustment system was agreed for the UK. For  1984,  the UK would
receive a one-off  ECU  1 billion (approximately £600 million) rebate equivalent
to about 50%  of  its net contribution. From  1985  onwards,  she  would  receive
66%  of  the difference between its share of the VAT payments and its share of
expenditure allocated for the year in question. (The reason for this formula was
the  view  of  other Member States that traditional own resources should not be 
included in the calculation). It was agreed that these refunds would continue until
any further increase in the VAT ceiling was agreed upon. In addition, Britain's
1983 rebate of ECU 750  million (£440 million),  which had been temporarily
frozen,  was released.

An  agreement  in  principle  that  any  Member  State  which  should  sustain  a
budgetary burden considered excessive in relation to its relative prosperity could
be entitled to a correction at the appropriate time. This would be determined, as
in the case of the UK, by the difference between its share of VAT payments and
share of expenditure.

The cost of the UK rebate to be shared out among the Member States according
to their normal VAT share. However, a ceiling was placed on Germany's share
equal to two-thirds of its VAT share.

A2.15. Although the Fontainebleau Agreement raised the level of own resources, the increase 
in the  maximum  VAT  rate  agreed  was  substantially  less  than  the  Commission  had 
proposed  in its draft decision of 6 May  1983 (See OJL  145,  3.3.83). The Commission 
called for the maximum VAT rate  to rise from 1 % to 2%. Indeed, compared with radical 
changes that the own resource system would subsequently go through, these revisions 
to the Luxembourg Agreement were m oderate. A revised draft decision (COM (84) 384 
final,  of  9  July  1984),  was  put  before  the  Council  in  line  with  the  Fontainebleau 
Agreement.  However,  the  Pfennig  Report  (EP,  1984)  drawn  up  on  behalf  of  the 
Parliamentary  Committee  on  Budgets,  and  subsequently  adopted  by  Parliament, 
expressed severe reservations in respect of the proposed legislation. In short, the report 
considered  the  UK  settlement  to  be  an  attack  on  the  system  of  own  resources  and 
proposed that the settlement of budgetary imbalance, specifically in the case of the UK, 
should take the form of an adjustment on the expenditure side of the budget. However, 
the Commission's draft Decision was adopted, unchanged, by the Council in Decision 
85/257/EEC of  7 May 1985 (See OJC  128,  14.5.85). 

A2.16. In terms of providing sufficient revenue, the Fontainebleau Agreement proved, almost 

A-9

immediately, to be inadequate for three main reasons. First, traditional own resources -
agricultural levies, sugar levies and customs duties - were declining. Between  1982 and 
1988 the percentage of own resources made up of agricultural and sugar levies halved. 
During the same period,  the percentage of own resources made up of  customs duties 
declined from one third to one quarter. These declines ensured that the new maximum 
VAT ceiling of 1.4% was reached in its first full year.  Secondly, the  VAT base was 
growing at a slower rate than economic activity because of the reduction in the share of 
consumption in total GNP. Thirdly, the budget adjustment mechanism agreed in respect 
of UK contributions had the effect of  reducing the effective  VAT call-up rate from 
1.4% to  1.25%. The reason for this was that the cut in Britain's VAT contribution was 
paid  for  by  an  increase  in  the VAT  contributions  of  other  Member  States  up  to  a 
maximum  of  l .4%. The  effect  was to  bring  down the  uniform  rate as applied to  all 
Member States to 1.25%. 

A2.17. The problem of inadequate revenues was compounded by rising spending commitments 
which had in part been anticipated. Despite the measures agreed by the Farm Ministers 
in March, 1984, agricultural spending began to grow faster than before. Partly, this was 
caused by the entry of  Spain and Portugal whose agricultural output added to existing 
surpluses in certain sectors. Partly, too, it was caused by a fall in world commodity prices 
combined with a decline in the value of the US dollar raising the cost of export subsidies. 
The  1.4.%  VAT  ceiling  was  reached  in  both  1986  and  1987,  a  crisis  only  being 
forestalled by a variety of artificial devices on the spending side including a delay in the 
payment of agricultural advances under the EAGGF. 

The Brussels Agreement (1988) 

A2.18. In  1987,  the  Commission  published  a  new  set  of  proposals  for  changing  the 
Community's own resources system designed to provide greater financial  stability for 
the  Community. It proposed that the  revenues of the Community  be capped for  the 
period from  1988  up to  1992 at a level equivalent to  l .4% of the Community GNP 
( equivalent to a  2% VAT  ceiling). It was further proposed that the limit should  rise 
gradually year by year thereby ensuring that unexpected expenditure could be catered for 
within  existing  rules.  The  Commission  also  proposed  that  in  respect  of  VAT  the 
maximum  rate should  be reduced from  1.4% to  1% and  be levied on  the actual as 
opposed  to  the harmonised base.  Traditional own resources were to  be  bolstered by 
incorporating customs duties hitherto  subject to the ECSC Treaty. It was also proposed 
that the  I 0% of customs duties which was remitted to Member States should in future 
go the Community. However, the central feature of the Commission's proposals was the 
plan to introduce a fourth resource, to be levied on the difference between the GNP and 
VAT base for each Member State. The intention was to make own resources conform 
better to ability to pay than could be achieved through a system based on VAT revenues. 
This is because VAT payments are based on levels of private consumption and  richer 
Member States tend to have lower ratios of private consumption spending to GNP. 

A2.19. The  view  of  the  European  Parliament  on  these  original  proposals  was  somewhat 
ambivalent. In the second report drawn up on behalf of the Committee on Budgets, on 

A -10 

the proposals from the Commission, the Baron Crespo Report, a number of objections 
to the proposals were spelt out: 

'The Commission is now attempting to make the budget fairer by 
introducing  a  fourth  source  of income  based  on  the  Member 
States'  GNP.  However,  this weakens the  status of Community 
revenue  as own  resources  considerably;  the  revenue  accruing 
from value added tax is to be cut back from the present rate of 
1.4% to 1 % of the uniform assessment base. It is replaced by a 
fourth source of income which corresponds to a percentage of the 
Communities'  GNP.  This  merely  constitutes  another  financial 
contribution from the Member States. It is a step backwards for 
the Communities' financial autonomy' (EP, 1987) 

A funher objection was raised  with respect to the proposed ceilings on own resources, 
which the Report considered: 

' ... this type of arrangement would serious! y curtail its budgetary powers 
and would be  incompatible with Article 203 of the Treaty' (EP,  1987) 

The  Report's  alternative proposal  was to gear VAT to GNP in such a  way that each 
Member  State would pay a given percentage related to its economic capacity.  It also 
proposed that consideration should be given to the introduction of a new levy such as a 
tax on  mineral oil  products which  was connected with tax harmonisation  within  the 
Single Market but which would also ensure fair distribution. 

A2.20. These proposals were considered by the European Council meeting in Brussels on 11-13 

February 1988. The proposals of the Commission were agreed with a few changes: 

•

•

•

•

A ceiling for the Community Budget was agreed of 1.2% of GNP for payments
and 1.3% for commitments up to 1992. This was  less than the 1 .4% proposed by
the Commission. (The new 1.2% ceiling for payments was equivalent to a ceiling
of between 1.9-2% in VAT terms).

Intermediate  annual  ceilings  were  laid  down  for  payment  appropriations  of
1.15% in 1988, 1.17% in 1989, 1.18% in 1990, 1.19% in 1991 and 1.2% in 1992.
(Payment appropriations determine the actual amounts of revenue required).

The maximum call-up rate for VAT was maintained at 1 .4% (not reduced to 1 %
as proposed by the Commission). However, the VAT base for the purposes of
determining VAT payments was not to exceed 5 5% of the GNP for any Member
State with a per capita GNP 90% below the EC average.  This mainly benefitted
Ireland,  Luxembourg and the UK in  1988, and Portugal and Greece in 1989.

The proposal to replace the harmonised with the actual VAT base for purposes
of assessment was dropped.

A -11 

•

•

•

•

ECSC duties would be incorporated into the revenue structure as proposed by the
Commission.

Member States would continue to  retain  I 0% of the revenue from traditional
own  resources to cover the costs  of collection,  contrary to  the Commission's
proposed addition.

The  proposal  for a  new fourth resource based on  GNP  was  accepted.  It was
agreed that this would be equal to the difference between the amount collected
from VAT and traditional own resources in any particular year and the amount
required to cover spending based on the GNP of the Member State. For example,
if the revenues required to finance spending amounted to  1.2% of EC GNP and
the revenues from the first three own resources was 1.1 % of GNP, each Member
State would be asked for a further contribution equivalent to O. 1 % of its GNP.

The adjustment agreed at Fontainebleau in respect of the British net contribution
was retained and would continue to be borne by the Member States in accordance
with their VAT payments.  Once again, Germany's share was restricted to two­
thirds of its VAT share.

A2.21. As in  1984,  the Agreement  was  preceded by an agreement of Farm Ministers to take 
further measures to control CAP spending. In February, 1988, Farm Ministers agreed on 
a package of measures including a ceiling on the gro-wth of  EAGGF  Guarantee spending 
equal to 74% of the Community's GDP growth-rate.  Other measures included the use 
of  "agricultural  stabilisers"  providing  for  automatic  price  cuts  if  cereal  producers 
exceeded thresholds and a scheme to encourage farmers to set-aside arable land from 
production. 

A2.22. One  consequence  of  the  Brussels  Agreement  was  the  settlement  of  the  uniform 
arrangements in respect of the VAT own resource. Regulation  1552/89 confirmed that 
the revenue method would become the sole definitive method for determining the VAT 
resource  (See OJ L155,  7.6.89).  The logic behind this decision was  that  the revenue 
method had  proved  reliable and had already been applied by the majority of Member 
States. However,  as  we have seen, it amounted to a significant movement away from 
VAT  payments being a genuine own resource rather than a device for calculating the 
contributions of the Member States. In April 1988, the Commission submitted proposals 
for  harmonising  the  calculation  of  gross  national  product  at  market  prices  for  the 
purposes of calculating the fourth resource although these proposals were not adopted 
until February, 1989. 

A2.23  In  providing  the  Community  with  increased  finance  to  meet  its  expenditure 
commitments, 
the  Brussels  Agreement  was  a  success.  1988  actual  payment 
appropriations represented just  1. 11 % of GNP, 0.01 % below the allowed ceiling. This 
gap  increased in  1989  to 0.04%  and the own  resources required  in  1990  were 0.2% 
below the level anticipated in the 1988 Financial Perspective. Essentially there were two 
reasons  - reductions  in  EAGGF  expenditure  and  faster  economic  growth  in  the 

A -12 

Community.  This  last factor  also had the effect of increasing the VAT base and as a 
result the need to tap into the fourth resource  was less than anticipated. In consequence 
the environment in which proposals were put forward on own resources for the period 
after 1992 was substantially different from that which preceded the Brussels Agreement. 

The Edinburgh Agreement - Financial Perspective,  1993-9 

A.2.24. In March  1992,  the Commission published its review of the own resources system in a 
document "The  System of Own Resources"  and set out proposals for the period after 
1992 (COM(92)final, March  10 1992).  There were two main concerns. The first was to 
secure a  level of funding sufficient to meet the new  policy commitments arising out of 
the Maastricht Treaty.  The second priority was to effect a re-distribution of the burden 
of the own resources between member states. This view stemmed from the Maastricht 
Protocol  on  Economic  and  Social  Cohesion  and  the  concern  that  the  contributive 
capacity  of  individual  member  states  be  taken  into  account  in  the  system  of own 
resources. It also meant that a greater importance should now be attached to the issue of 
fairness in the budgetary system. 

A2.25. To achieve these objectives, the Commission proposed an increase in own resources from 
1.2% of GNP in 1992 to 1.37% in 1997. It proposed that this should be financed entirely 
from the GNP-based fourth resource in order to reduce dependence on VAT.  It argued 
that the main cause of unfairness in the own resources system was the regressive nature 
of the VAT resource. This issue had been addressed in the Brussels Agreement at which 
VAT payments had been capped at 55% of GNP for those Member States with GNPs 
below 90%  of the Community average.  However, the poorer Member States quickly 
reached  this  limit  whereas  some  richer  Member  States  were  paying  less.  The 
Commission proposed to deal with this problem by reducing the  VAT call-up  rate to 
1% from the existing 1.4% and lowering the ceiling on VAT payments to 50% of GNP. 
Lower VAT payments would be offset by an increase in revenues from the GNP-based 
fourth  resource.  As  a result a greater financial burden would fall on those countries 
whose share of Community GNP exceeded their share of the Community's VAT base. 
The Commission acknowledged that its proposals for reducing the importance of VAT 
and increasing the role of GNP-based contributions did amount to a further weakening 
of the own resource system because GNP-based payments bore a great resemblance to 
Member State contributions. 

A2.26. However, the proposals also contained a statement of the desirability of creating a new 
fifth resource. The reason was the perception that the existing third and fourth resources 
were, unlike traditional own resources, mere budgetary contributions from the Member 
States.  It  argued  that  there  was  a  need  to  reduce  the Community's  dependence  on 
national governments for finances and to give to the Community greater flexibility in 
exercising its budgetary responsibilities. Although there were no suggestions as to what 
form this should take, certain criteria which such a tax should satisfy were suggested:-

•

Fairness

A - 13 

•

•

•

•

An effective harmonised base

A linkage to a common policy area

Being capable of providing a reliable and predictable flow of revenue

Clear visibility to the taxpayer

A2.27. The Commission went on to state: 

"The Commission has examined various possibilities concerning taxes at 
the national level whose proceeds could be shared with the Community. 
However,  it  has  found  that,  at  present,  no  candidate  exists  that  is 
sufficiently harmonised". 

The desirability of finding such a resource in the medium-term was established and the 
Commission promised to create the conditions for allowing such a resource to be created. 

A2.28. At  the  Edinburgh  meeting of Heads  of State  of  11-12 December  1992,  a  modified 

version of the Commission's proposals was adopted: 

•

•

•

•

A budgetary ceiling increasing from 1.2% of GNP in 1992 to  1.27% in 1999 was
agreed.  This  was  a lower  ceiling  than  that proposed by  the  Commission  and
spanned a seven-year period instead of five years.

Intermediate annual ceilings on own resources for payment appropriations were
agreed as  follows:  1.2% in  1993  and  1994,  1.21 % in  1995,  1.22%  in  1996,
1.24% in 1997, 1.26% in 1998 and 1.27% in 1999.

The ceiling on the VAT call-up rate was to be reduced from  1.4% to  1.0%,  in
equal steps over the period 1995-1999.

For countries with a per capita GNP of less than 90% of the community average
the assessment base for VAT payments was to be  limited to 50% of a Member
State's GNP. This change would also be introduced in equal phased steps over the
period 1995-1999.

A2.29  The  Commission  submitted  revised  proposals  for  a  Council  Decision  based  on  the 
Agreement reached at Edinburgh. These proposals were then submitted to the European 
Parliament for approval.  Not surprisingly, Parliament was much less sanguine about the 
new proposals. A particular concern was the proposed movement away from reliance on 
VAT payments and towards greater dependence on GNP-based contributions which was 
viewed  as  a  further  retreat  from  the  own  resources  approach..  The  Report  of the 
Committee on Budgets on the Commission's proposals argued: 

'Parliament upholds its view that VAT ought to be central to the own 

A - 14 

resources and that it should be levied direct from the tax-payer, creating 
greater transparency, identification and justice and placing the union on 
an independent footing.' 

This  Report  also  critigi,sed  the  Commission  for  justifying  proposals  by  reference to 
decisions  of  the  European  Council,  referring  to  its  lack  of  statutory  status  as  an
institution of the Union or as part of the budgetary authority.  The Report stopped short 
of rejecting the Commission's proposals, as it felt this would jeopardise the continuity 
in  the  financing  of the Union.  However,  it made a strong  plea  for a comprehensive 
review of the ov.n resource system to be made in the future. The Edinburgh Agreement 
took effect on  I  January, 1995 following the passing of Council Directive 94/728/EC 
(See OJL, 12.11.94). 

A-15

Annex 3 

The Legal  Base for Own Resources 

Treaty 

I. Anicle 201 of the original EEC Treaty required the Commission to examine 'the conditions
under which the financial contributions of member states provided for in Article 200 could
be replaced by the Community's own resources, in particular by revenue accruing from the
common customs tariff when it has been finally introduced'.  There was provision for the
Commission to submit proposals, consultation of the Parliament., unanimous adoption by the
Council  and  ratification  by  the  member  states  in  accordance  with  their  respective
constitutional requirements.

2. This  text,  having  become  completely  outdated,  was  replaced  by  Article  G(71)  of the
European Union Treaty in 1991.  The effect of the new wording was to replace the first part
of the Article with the following:  'Without prejudice to other revenue, the budget shall be
financed wholly from own resources'.  The procedure for proposal,  consultation, unanimous
decision and member states ratification remain in force, subject only to drafting changes.
The Amsterdam Treaty made no changes to the Article and so it will remain the sole legal
base.

3. The last occasion on which an additional type of own resource was introduced was by the
Own Resources  Decision of 24 June 1988.  This  introduced revenue 'based on the sum of
member  states'  GNP'.  The  decision  followed  a  proposal  by  the  Commission  and
consultation of the European Parliament.  It was ratified by all member states in accordance
with their respective constitutional procedures.

4. As  on  that occasion,  any  new  own  resource  must  be  adopted  in  accordance  with  the
procedure set out in Article 201.  Even if some devious legal route could be established as
an alternative, it would be impracticable to introduce a new own resource without the willing
compliance of the Commission and all the member states.  It is highly  unlikely that such
compliance could be achieved without proceeding in accordance with Article 201.

Implementing Rules 

5. Article  209  provides  for  the  Council,  acting  unanimously  on  a  proposal  from  the
Commission and after consulting the European Parliament and obtaining the opinion of the
Court of Auditors,  'to determine the methods and procedure whereby the  budget revenue
provided under the arrangements relating to the Community's own resources shall be made
available to the Commission, and determine the measures to be applied, if need be, to meet
cash requirements•.  These regulations are detailed in nature and their purpose is clear from
the use of the word  'implementing' in the title.

6. The European Parliament could not  use the implementing rules to achieve any change of
principle,  partly because  it  would  be  beyond  the scope  of the  legal  base  used  for  these
regulations (Anicle 209) and partly because unanimity in the Council  would  be required.
It could, of course, make significant changes to the manner of implementation if the Council

A- 16

agreed  with  the  Parliament.  However,  implementing  rules are  beyond the  scope of the 
present report. 

The Annual Budget 

7. Article  203  sets  out  the  procedure  for  adopting  the  annual  budget. 

It  lays  down  the
respective  powers  of  the  Council  and  the  Parliament  based  on  the  distinction  between
compulsory  and  non-compulsory  expenditure. 
It  limits  the  Parliament  to  proposing
'modifications'  in  respect  of  compulsory  expenditure.  However,  it  fails  to  draw  any
distinction  between  amendments  relating  to  revenue  and  amendments  relating  to  non­
compulsory expenditure.  Thus the European Parliament has always argued that it has power
to amend the revenue  side of the budget.  The Council,  on the other hand, has argued that
revenue cannot be so amended.

8. This debate, to which the European Court of Justice has also contributed some comments,
has no relevance to the creation of new own resources.  The Parliament's hands would be
tied in two respects.  The Court of Justice has indicated that legislation has primacy over the
budget.  Therefore  the  estimates  of  revenue  must  reflect  the  Own  Resources  Decision.
Furthermore, the estimates of revenue arising from own resources are simply a reflection of
the expenditure decided.  Thus the Parliament's powers in the annual budgetary procedure
cannot be used to create a new own resource or to modify the system in any significant way.

Fundamental Principles 

9.

It may be argued that the nature of a democratically and directed elected Parliament gives
an inherent power to determine taxation. 
'No representation without power of taxation'
might  be the refrain.  However,  this would  require a radical departure from the existing
jurisprudence of the European Court of Justice.

l 0. The European Union has the constitutional structure laid down in the Treaties.  One of 
the main purposes of the Treaties is to determine the scope of the European Union's 
authority  and  the  balance  of  power  within  the  institutions  which will  exercise  that 
authority.  The  argument  that  the  democratically  elected  European  Parliament  has 
inherent powers going well beyond those laid down in the Treaties could only be based 
on much more wide ranging concepts of inherent powers and primacy of the Union over 
its member states. 

11. Whereas  sovereignty  now  rests  with  member  states  except  to  the extent they  have
surrendered it to the Union, this argument would transfer final sovereignty to the Union
level.  The pendulum may swing in that direction in the future but there is no possibility
that the European Court of Justice would support any such claim at the present time.

The European Parliament's options 

12.

The European Parliament has the possibility of proposing new types of own resource in

A-17

at least two ways: 

• 

•

by  adopting  amendments  to  the  next Commission  proposal  for an  Own  Resources 
Decision; or 

by adopting an own initiative report, possibly based on the Commission's report on the
operation  of  the  own  resources  system  required  by  Anicle  10  of the  current  Own
Resources Decision ( even if that report did not include a proposal for a new Decision).

l3. 

Thus the Parliament could determine its own stance and seek to persuade the Council.

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