UK: SMITH ON ECONOMICS - TAX AND SPEND IS THE EURO-NORM. - A worrying aspect of economic convergence has been ignored in the debate over EMU, says David Smith - the pressure on the UK to increase spending and taxation in line with Europe.

Last Updated: 31 Aug 2010

A worrying aspect of economic convergence has been ignored in the debate over EMU, says David Smith - the pressure on the UK to increase spending and taxation in line with Europe.

I cannot think of an issue on which businessman are so divided as Europe. Hang on, let me rephrase that. I cannot think of an issue on which there are bigger differences than economic and monetary union (EMU) and the single currency. A mildly positive piece on the subject is met with letters of congratulation, along the lines that at last someone in the British media has escaped from the ugly grip of jingoism and scepticism.

A negative piece, on the other hand, gets a 'more power to your elbow' postbag, often from people who lay great stress on their belief in the single market and on other aspects of European integration.

Now it's a matter of instinct

EMU has succeeded in dividing British business attitudes to Europe in a way that has not been seen since the debate about entry into the then European Economic Community a quarter of a century ago. Then, it was possible to divide the pros and antis according to the perceived threat, or gain, to their sector. Attitudes for or against EMU, however, seem much less calculated and much more instinctive.

The difficulty of framing an agreed line on British participation in EMU - and, as noted last month, a decision will have to be taken this year - has stymied the Confederation of British Industry which, like the Government, has decided to leave its options open until closer to the time. The Engineering Employers Association, however, has decided to go for it, taking the view that if the final stage of EMU goes ahead on 1 January 1999, Britain should be part of it or risk, as in earlier episodes of integration, coming in when others have carved out arrangements that work to their own national advantage.

This is not the time to go over the arguments for and against the single currency again. There is, however, one aspect of economic convergence - in or out of EMU - which should concern us. My worry is on the fiscal side - tax and spending. Despite a less than impressive record over the past five years, Britain is a country which has lower taxation and lower public spending as a proportion of national income than the rest of Europe.

Business should be well aware of its favourable tax position. High taxes, particularly the social costs levied on business, are one of the reasons for Europe's loss of global competitiveness. Britain has the lowest main rate of corporation tax of any major industrial country. Business taxes account for 6% of gross domestic product in Britain, compared with 9% in Germany and 15% in France.

Perhaps in retrospect it would have seemed quite natural for a British administration to have followed its European partners down this road by using North Sea tax revenues to fund higher levels of social provision.

But the IMF crisis of 1976 and the election of the Thatcher government in 1979 changed all that. One of Mrs Thatcher's most important acts was to break the link between pensions (and other social security benefits) and earnings - linking them instead to prices and at the same time encouraging far higher levels of private pension provision.

Thus, while the effect of Britain's ageing population is calculated by the OECD (Organisation for Economic Co-operation and Development) to add 2.1% of GDP to spending on health and state pensions over the next three decades, the figures in Germany (5.8%), France (5.6%), Belgium (6.1 %) and the Netherlands (10.2%) are much higher. The rest of Europe taxes and spends a lot now, and the pressure will be on for them to do so even more in the future.

Long-term repercussions

According to the OECD: 'Countries will have to face the problem of the ageing of their populations and under current pension rules, it is clear that meeting pension obligations will entail significant rises in public expenditure. As populations grow older other related expenditure, such as health care, will also tend to rise. Offsetting these additional expenditures by tax increases would require increases in tax-to-GDP ratios estimated at more than five percentage points in most countries. Where tax pressure is already high, such further increases may have repercussions on labour markets and elsewhere which would render them unsustainable.'

The challenge for Britain, then, is to avoid fiscal contamination from the rest of Europe - the pressure to increase taxation and spending into line with the 'Euro-norm' at a time when all the economic evidence suggests we should be trying to reduce the state's share of national income. Unlike EMU, I suspect this is a line which the vast majority of businessmen would agree with.

EMU - only a staging post?

It is why we should take seriously the creative accounting and window-dressing that many countries in Europe appear to be using to meet the Maastricht debt and deficit criteria without tackling the underlying problem of rising long-term pressures to boost public spending. Whether in or out of EMU, the single market is going to be worth a lot less to British business if it is dragged down by punitive levels of taxation.

At its most extreme, the danger is of EMU being merely a staging post.

There are those in Brussels who talk of monetary union being followed, after a decent interval, by fiscal union. Other countries in Europe are concerned about Britain's competitive advantage when it comes to low levels of taxation. Tax harmonisation results in limiting a low-tax country's ability to engage in tax competition for its own advantage.

EMU, as I say, is a topic guaranteed to lead to polarisation among businessmen.

Perhaps we have all taken our eyes off another important ball. The dangers on the fiscal side are arguably greater than those arising from closer monetary integration, although plainly the two are related. This one should be watched very closely.

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