Taxation and Grants Policy in Multilevel Government: Options for the European Community

The development of the European Community is likely to be financed through expansion of tax sharing on VAT and by introducing general-revenue sharing indirectly. Tax sharing on VAT does not necessarily imply the harmonisation of tax rates, however. Other options for revenue equalisation schemes are the transfer of tax bases to the centre that exhibits implicit distributional effects. It is argued that capital taxation is the Achilles heel of any future tax system given the fact that—in globalised capital markets—effective marginal tax rates will more and more influence the international flow of capital, a phenomenon that forces governments into tax competition through market processes. A cash-flow corporation tax seems to be likely to become more and more prominent as an alternative to comprehensive capital income taxation. Applied at the Community level such a tax could serve as an implicit equalisation scheme that fosters developing regions by exempting new investment while taxing the proceeds from the more mature economic areas in the EC. It would also be neutral as to investment and financing decisions and it would attract savings funds from abroad to be invested in the Community. As far as explicit equalisation is concerned, it is argued that differentials among regions are best dealt with by a system of matching grants that concentrate on aspects of allocation rather than by general-revenue redistribution. Harmonisation of personal income taxation in Europe could also be achieved by introducing a piggyback tax onto the income tax system which taxes personal consumption at a flat rate. Shifting the centre of gravitation within these two-tiers of income–consumption taxation would allow national governments to maintain their sovereignty as regards allocative and distributive policy. The consumption tax part could also form the nucleus of a future supranational direct tax.