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EU taxation: geopolitical priority over income

At the recent G20 finance ministers’ meeting, French Finance Minister Bruno Le Maire stated that the chances of success of the first pillar were “very slim”, so “digital taxation should be extended to the European level as soon as possible.”. This analysis of the first pillar status is not surprising, and Le Maire’s response is consistent with previous EU statements.

However, it raises important questions for policymakers: Is EU taxation a mechanism for increasing revenue or just a geopolitical tool? If both are available, which one should I give priority to?

In geopolitics, For many years, the EU has been trying to use its access to the common market to influence the policies of third countries. This is often referred to as the “Brussels effect”, and has traditionally been achieved through EU regulatory mechanisms and standard setting efforts. The General Data Protection Regulations (GDPR), the Digital Market Act (DMA), and the Digital Services Act (DSA) are the latest examples of this phenomenon.

In most cases, companies using the common market must bear the costs of these regulations.
The role of the European tax system in generating the “Brussels effect” is usually limited to value-added tax systems, anti tax evasion policies, and transparency measures, as the tax system is a national capability. The focus of these policies is primarily on improving the efficiency of the common market (through freer commodity exchanges and better tax enforcement in member countries), rather than geopolitical competition.

In many cases, the 27 member countries need to unanimously adopt tax policies at the EU level, or EU policymakers must demonstrate that taxes address some of the shortcomings of the common market. This is often difficult to achieve legally and politically.

Recently, however, the EU has begun to add different types of European tax policies to its “Brussels Effect” toolbox.

In 2018, the Organization for Economic Cooperation and Development (OECD) international discussion on taxation in the digital economy began to accelerate. Parallel efforts have been made to design a global minimum tax rate. The results of these discussions have become the first and second pillars as we know them today.

At the same time, the European Union is attempting to impose tariffs on the European Digital Services Tax (DST), which mainly targets large US technology companies. Although this proposal did not receive the necessary support from all 27 member countries, it provided impetus for a range of national DSTs in EU member countries such as France, Austria, and Spain.

These policies have led to trade disputes with the United States, leading to a “DST ceasefire” between the United States and European member states that own the national DST in 2021. As a compromise, EU member states agreed to cancel the existing DST after the entry into force of Pillar I.

If the OECD completes the first pillar, the EU has already arranged for domestic revenue that may become a new resource for the EU. In addition, at the end of 2022, the European Council unanimously adopted a directive to implement the second pillar of the EU.

Given the nature of the second pillar, the implementation of the EU by the end of 2023 will make it more applicable in other countries. For example, Japan, South Korea, and the United Kingdom are all moving forward this year.

It also gives the EU a greater say in how to view the policies of other countries within the framework of Pillar II. According to the latest OECD guidelines, the US Global Low Tax Intangible Income (GILTI) clause should not be considered as a qualifying income inclusion (IIR) rule under the second pillar system. Even from January 1, 2026, the effective rate of GILTI will increase to 13.125% (which may increase to 16.4% or higher depending on the affordability of foreign taxes).

If the United States decides to reform GILTI in the future, the European Union (and its member States) will have an important say in whether to accept the reformed GILTI as a qualified IIR. This is an example of how the EU can use the common market to change the global tax system.

In other words, the “Brussels effect” not only affects the profits of companies using the single market, but also directly affects the tax base of countries outside the EU. The recently agreed carbon border adjustment mechanism (taking into account the economic impact of EU border tariffs), The proposed green agreement industry plan aims to compete with the United States’ Deflation Act and the European Union’s domestic market commissioner Thierry Breton’s fee plan, which may ultimately include fees paid to European infrastructure.

Although some policymakers hope to strengthen the role of the European Union in global affairs, there are three major risks in using European tax policies in geopolitical and economic competition.
First, it may trigger retaliatory trade measures or taxes by foreign governments against EU governments and companies (such as the US response to a digital services tax). These retaliatory measures may have negative economic impacts and inequality across the EU.

Secondly, this may lead to changes in European tax policy influenced by geopolitical circumstances rather than the principle of consistency. Overall, this will reduce efficiency and may threaten investment and economic growth. Based on the idea that current green agreement industry plans prioritize subsidies over market competition, some well-known policymakers fear that the EU’s response will eventually fall into this trap.

Finally, as Minister Le Maire’s comments indicate, the design of European tax policies can prioritize social ideology or geopolitical fronts, rather than adding sufficient revenue to government spending priorities. The negative impact of this approach on tax design has led to a debate over windfall taxes.
Therefore, the European Union places itself in a position of spending restrictions when income is uncertain. In 2021, the European Commission proposed three new resources to help fund the EU budget.

However, revenue from CBAM will be zero for at least the first period, if not longer. In addition, Pillar One has yet to be agreed upon by the OECD and a new digital tax will not generate a large amount of revenue. As a result, the EU will move to a new basket of new resource proposals later this year that will be “linked to the business sector”. Others in the European Parliament have called for more taxes at the EU level to focus on social policy implementation rather than revenue-boosting effects.

Meanwhile, 800 billion euros in COVID-19 relief money (called NextGenerationEU) has already started to be spent and needs to be paid back with interest starting in 2028. Not to mention the fact that interest rates are going up. to slow inflation and EU’s AAA rating based on on-time repayment.The most likely options for reimbursement to NextGenerationEU are to further increase EU revenue through new resources, increase Member State payments to the EU budget in the next Multi-Year Financial Framework (MFF) or cut EU spending in the next MFF by at least 10 percent . In addition to the current budget shortfall, the EU is looking to further finance Ukraine, provide relief to EU nationals affected by the increase in energy prices and borrow more money at the EU level to finance the loans. EU subsidies after inflation Reducing Act If the EU wants to compete strategically with economic powers like the US or China, the EU needs a principled pro-growth tax policy that prioritizes efficient ways results to increase revenue rather than geopolitical ambitions.Another attempt to levy a European digital services tax (or an EU digital tax) in the absence of Pillar One could leave EU policymakers feeling locally powerful. politically, but it could do more damage to the European economy in the long run.

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