Taxes are one of the areas where EU membership will bring about major changes. Unlike other transformations, changes in the tax code will affect all businesses and all people directly and inevitably.
In the area of taxation, EU member states are subject to minimal requirements. For some taxes, for example, personal and corporate income taxes, there are not any written rules. Some requirements are not so minimal and insignificant in scope or complexity. If considered from a free-market point of view, European documents establish the upper, or the maximum, limit of freedom. This means that the member states that have implemented EU directives cannot compete by providing businesses with more liberties than those stipulated by the EU law.
Member states can only tighten, but not loosen EU requirements. EU directives establish minimal mandatory obligations of the state but do not protect their citizens from excessive government. So EU laws, by their nature, impose no limits on the level of discretion that national governments enjoy, but at the same time the member states are restricted in their opportunities to compete by creating better business conditions.
EU directives are over-restrictive for those who seek a free market economy and limited government, but they are fairly propitious for the champions of a regulated market and active government. Harmonization with the EU acquis will require Lithuania to tighten tax rules that are less rigid as compared with those applied in the EU. However, if some requirements are stricter in Lithuania, there are no obligations to loosen them. So the chances of being the freest within the framework drawn by the EU depend on the national government as well.
Why should a national government be interested in free enterprise and low taxes? If the goal is to create conditions for seeking a better, more prosperous life, it should be realised that only a free market allows people to create the greatest wealth possible. Obviously, a free market does not guarantee that the greatest amount of wealth will be created. This depends on individual choice, on individual wish or reluctance to seek prosperity. The task of the government is not to stand in the way. Despite the fact that the EU club strictly defines the maximum level of freedom, national governments have leeway to seek it.
Indirect taxes – value added tax and excise duties – are those which the EU regulates in the most detailed manner. Here, there isn’t much room for interpretation in defining the tax base. Likewise, EU laws minutely define the tax objects, the minimal tax rates, and the rules of payment. Indirect taxes can help illustrate how approximation with the EU acquis will affect business conditions in Lithuania.
Let us take excise duties. In the EU, mandatory excise duties are applied to three categories of goods – tobacco, fuel, and alcohol. The minimum tariffs charged on those goods are much higher in the EU than those in Lithuania. This means that Lithuania will have to raise them. The negative effects of increases in excise duties are well known: consumer preferences are distorted, smuggling expands, the tax burden increases, and budget revenues fall.
The problem with excise duties is that Lithuania charges them not on three, but on eleven categories of goods. Although in the EU these excise duties are not obligatory, they are not prohibited either. Yet, Lithuania does not seem to be very keen on removing them. When a Sunset task force working on tax issues [the Sunset Commission was established by the government of Lithuania to formulate recommendations on how to ameliorate the existing rules in the areas of taxation, land acquisition, building, customs, employment, etc.] proposed to eliminate these excise duties, the government decided to first look at what effect this would have on budget revenues. Given that in Lithuania a short-term effect on the budget is considered to be the biggest concern, it is very unlikely that these excise duties will be abolished. So the growing opinion that policy affairs in Lithuania are run not by local officials but by the International Monetary Fund, the World Bank and the European Union is not completely correct.
VAT provides another example. Most changes relating to VAT that will have to be made while approximating the Lithuanian law to the EU acquis will restore economic logic (as, for example, in the case of taxation of exported services) and benefit the taxpayer. The minimum general rate of VAT established in EU directives is lower than the current 18-percent rate applied in Lithuania. To improve business conditions, the Lithuanian authorities could comply only with the minimum EU requirements. However, a reduction of the value added tax rate is not even discussed in Lithuania.
EU legal acts also define minimal special rates that Lithuania is going to adopt. By doing so, it will nullify the advantages provided by a uniform-rate system. In Lithuania, a proposal has been made to impose a 5-percent tax rate on transportation services. With the general tax rate of 18 percent currently in effect, the proposed 5 percent would mean a subsidy for carriers. In a market economy, no subsidies should be tolerated, and in the aforesaid case a consistent government would propose a tax rate of 18 percent, not 5 percent.
Other taxes – direct personal and corporate income taxes – are subject to minor requirements in the EU. These are related to taxation of certain types of income received by non-residents, establishing the principle of non-discrimination, as well as to tax breaks for small businesses and taxation of trans-national holding and subsidiary companies.
It should be noted that unwritten laws are almost as important in the EU as written laws. Although no formal requirements exist regarding the corporate income tax, the main reason why Lithuania failed to abolish the corporation tax was the unfavourable opinion of international organisations, especially OECD. Indeed, OECD tests tax systems existing in different countries with the aim of identifying tax rules that hamper competition and draws its bad books. Recently OECD identified tax rules in the EU member states that are ostensibly deleterious to competitive forces. Almost every country had at least one provision of this type. Some had as many as ten.
There was a fear that Lithuania might get in OECD’s bad books. However, having in mind the rules that OECD uses in identifying harmful tax regimes, there is no way Lithuania could get there. On the other hand, it might seem there is no way Lithuania could avoid it either, as OECD has blemished some countries that could in no way match its criteria. Therefore, OECD provisions should not be used as an argument in adopting tax policy decisions.
What can a country that wants to pursue a free market economy but cannot change EU norms do? There are still possibilities to act within the framework drawn by the EU, and these possibilities should be exploited to the utmost. First, it is essential to negotiate over the longest possible transition periods in the area of taxation, preserving higher competitiveness by virtue of a lower tax burden. Second, changes to the legal acts should be limited to minimal requirements stipulated by the EU. Third, tax rules that are not required by the EU should be loosened so that they can offset the negative effects of harmonisation. Finally, it is important to exploit the period of time that is left before joining the EU and to follow during this period economic logic and economic needs rather than the lines of directives.