Policy narratives in the European Union : the case of harmful tax competition

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EUI WORKING PAPERS

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Euro pean U n iversity Institute © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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EUROPEAN UNIVERSITY INSTITUTE, FLORENCE

ROBERT SCHUMAN CENTRE

Policy Narratives in the European Union:

The Case of Harmful Tax Competition

CLAUDIO M . RADAELL1

University of Bradford and RSC Jean Monnel Fellow 1998

WP

3 21.0209

4 EH8.0EU/7

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EUI Working Paper RSC No. 98/34

BADIA FIESOLANA, SAN DOMENICO (FI)

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without permission of the author.

© Claudio M. Radaelli

Printed in Italy in October 1998

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Abstract'

This paper investigates the dynamics of the European Union (EU) direct tax policy process by drawing attention to the political power of policy narratives. The narrative of harmful tax competition has been a political instrument for rekindling attention to a previously neglected policy area. Through this narrative, a rhetorical momentum has been achieved, and the policy discourse has shifted from tax neutrality to the perverse impact of unbridled tax competition on employment and the welfare state. Narratives do not operate in a political vacuum, however. An organisational change, that is, re-inventing the Commission as a tax policy forum, has accompanied the emergence of the narrative. An important consequence of this has been a change in the structure of the direct tax policy process. By re-presenting itself not as a component of an advocacy coalition, but as a forum for inter-governmental deliberation, the Commission has curbed adversarial politics and created the pre-conditions for the adoption of a code of conduct on special tax regimes.

Acknowledgements

This paper arises out of research conducted with the support of the UK Economic and Social Research Council, grant R000222059. The paper was written during my Jean Monnet Fellowship at the European University Institute (Florence, Italy), Robert Schuman Centre. An earlier version of the paper was presented to the ECPR joint sessions of workshop 1998 (University of Warwick) and to the Robert Schuman Centre luncheon seminars. 1 wish to thank Dietmar Braun and Andreas Busch - coordinators o f the ECPR workshop on the role o f ideas -, Giuliano Amato, Maurizio Cotta, Fabio Franchino, Philipp Genschel, Pierangelo Isernia, Sonya Mazey, Yves Mény, Simona Piattoni, Marc Smyrl, Jeremy Richardson, Anthony Zito, and two anonymous reviewers for their perceptive comments. The usual disclaimer applies. François D. Lafond (Robert Schuman Centre) provided an excellent organisation of the editorial work. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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1. INTRODUCTION: NARRATIVES, ADVOCACY COALITIONS, AND POLICY CHANGE

In this paper I examine the European Union (EU) direct tax policy process in its narrative components. Recently, the EU literature has drawn attention to the role of knowledge in EU politics. This is part of a more general re-discovery of the ‘power of ideas’ in comparative politics (Hall 1989; 1993; Majone 1989) and international relations (Jacobsen 1995). But the EU fascinates its observers because of the elusive fluidity of the policy process (Richardson 1996), the importance of persuasion in a multi-tiered political system (Smyrl 1998), the pivotal position of communities of experts (Verdun 1996), the politics of issue- framing (Radaelli 1997), and the assumed technocratic approach of the European Commission (Featherstone 1994).

Agenda setting (Bachrach and Baratz 1962), and especially the definition of policy problems (Rochefort and Cobb 1994), is the stage of the policy process where knowledge seems to play an important role. In the case of the EU, the agenda is quite permeable to alternative definitions of policy issues and consequently conflicts over the interpretation of problematic situations abound (Peters 1996).

Knowledge is also a fundamental component of one the most sophisticated approaches to the study of policy change that has emerged in recent years, that is, the advocacy coalition framework (Sabatier and Jenkins-Smith 1993). The approach has potential for the analysis of EU public policy, as shown recently by Sabatier (1998). To sum up then, the role of knowledge, agenda-setting and advocacy coalitions represent the main dimensions upon which this study is grounded.

In addition, recent EU studies have discussed the conditions under which supra-national institutions such as the European Commission enjoy autonomy from member states. This debate on supra-national agency (Moravcsik 1993; Pollack 1997) has introduced the hypothesis that the Commission can shape the preferences of member states by providing conceptual innovation and by engaging in reasoned persuasion (Smyrl 1998). Why should member states change their preferences in light of the Commission’s entrepreneurship? One hypothesis is that the Commission can exploit the short-term horizon of national policy-makers sitting in the Council (Pollack 1997). However, Smyrl argues that member states are not just ‘tricked’ into accepting the policy goals of the Commission. Rather, member states can be ‘persuaded by the Commission’s arguments’ and ‘apply them knowingly and willingly’ (Smyrl 1998, 90).

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‘Constructivists’ would add that the policy environment in which member states act is social as well as material. The socially constructed environment provides actors with an understanding of their interests; it can even constitute them (Checkel 1998). Policy narratives are an important component of the cognitive structure (Radaelli 1997) - or the référentiel (Faure et al. 1995). The latter contributes to shaping the preferences and interests of actors engaged in EU public policy. However, there is interaction between actors and structure. ‘The ontology’- Checkel explains - ‘is one of mutual constitution, where neither unit of analysis - agents or structures - is reduced to the other and made ontologically primitive’ (Checkel 1998, 326).

This is where the aforementioned debate on supra-national agency becomes extremely useful. By showing how the Commission is active in diffusing policy paradigms and in building the cognitive structure of public policy, it is possible to avoid ‘the metaphysical pathos of institutional theory’ (DiMaggio 1988,9). The cognitive structure of public policy is not a ‘metaphysical’, free- floating entity, but the concrete product of a political process wherein purposeful actors provide and diffuse interpretation, narratives and paradigms. Knowledge is produced - not only reproduced - through the interaction in the policy process. Therefore the study of narratives can be employed to inform the debate on supra national agency, an issue to which I will turn in the conclusions of this paper.

However, do policy narratives really matter? A reasonable - but ultimately flawed - objection to the idea of considering arguments, ideas, policy paradigms and narratives as autonomous components of the policy process is what I would call the ‘tip of the iceberg’ argument. The latter posits that ideational variables represent only the tip of the policy iceberg, that is, the epiphenomenal part of the public policy making process. What moves ideas are interests, perhaps camouflaged behind the tip, but still very solid and powerful in determining the trajectories of policy. A response to this argument is that the consideration of ideational variables is a methodology for the empirical study of power. Knowledge and power - to begin with - are in symbiotic relationship (Radaelli 1997, chapter 9). Consequently, under conditions of uncertainty and polarisation, the conflict between one narrative and another is a conflict for power in the policy process. Asymmetric narratives (for example a narrative which is considered more acceptable than another) are ipso facto asymmetric relations of power. Roe has made this point in a convincing passage that is worth quoting at length,

‘It is only by watching who ends up ‘telling the better story’ or 'making the better case’- that is, who ends up on the side of the scenario that actually underwrites and stabilises the decision making in the face of controversy - that we come to any kind of understanding as to who has more or less power in getting people to ‘change their

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stories’, when changing them matters for decision making. In such circumstances, asymmetrical narratives do not reflect or mediate power relations: rather, they instantiate them. It isn’t that what is ‘behind’ narratives are the power relations that form them as much as what is ‘in front o f us is power in form of winning and losing narratives. When all else remains uncertain in a controversy, our knowledge of asymmetrical narratives is our knowledge of power' (Roe 1994,72-3).

However, what types of narratives matter in political life? Narratives relevant to policy-making generally have the shape of causal stories (Stone 1989). Examples of common policy stories are the tragedy of the commons, global warming, and the poverty trap. A policy story revolves around a causal sequence of events or positions. Stories have a beginning, a middle, an ending, and occasionally even a moral conclusion like in Sixteenth century morality plays (Garvin and Eyles 1997, 66-7).

It is important to bear in mind the distinction between stories, on the one hand, and ideology and myth, on the other. Following Roe (1994,36-37) ‘Less hortatory and normative than ideology, policy narratives describe scenarios not so much by telling what should happen as about what will happen - according to their narrators - if the events or positions are carried out as described. Even when their truth-value is in question, these narratives are explicitly more programmatic than myths and have the objective of getting their hearers to assume or do something’. The function of policy stories is to underwrite, that is, to ‘certify’, and to stabilise ‘the assumptions needed for decision making in the face of what is genuinely uncertain and complex. As such, policy narratives can be representationally inaccurate - and recognisably so - but still persist, indeed thrive’ (Roe 1994,51).

In addition, policy frameworks (Jobert 1989; Schon and Rein 1994) and metaphors (Schon 1979) supply the conceptual background and key images to actors engaged in complex policy making. Framing consists of ‘selecting, organising, interpreting, and making sense of a complex reality so as to provide guideposts for knowing, analysing, persuading, and acting. A frame is a perspective from which an amorphous, ill-defined problematic situation can be made sense of and acted upon’ (Rein and Schon 1991, 263).

A characteristic which policy frames and stories have in common is that they are employed by actors in order to act under conditions of uncertainty, conflict and complexity. When policy issues are not complex, divisive or uncertain, action proceeds without the clash of competing frames or divergent stories. The issue of polarisation paves the way for analysing narratives within the advocacy coalition approach. Advocacy coalitions can be defined as individuals

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from a variety of positions ‘who (a) share a particular belief system and who (b) show a non-trivial degree of coordinated activity over time’ (Sabatier 1998.115).

Two points concerning coalitions will be explored in the remained of this paper. The first point regards the belief system. Agreement over policy core beliefs is - according to Sabatier (1998,105) - the ‘glue holding a coalition together’. Policy core beliefs are ‘fundamental policy positions concerning the basic strategies for achieving core values’ (Sabatier 1998,112). They include normative and empirical precepts. Policy core beliefs with an empirical component define, for example, the overall seriousness of a policy problem, the causes of the problem, and the proper distribution of authority among levels of government (Sabatier 1998,112). By contrast, secondary beliefs concern instrumental decisions necessary to implement the policy core, and ‘deep core' beliefs are at the level of ontological axioms and fundamental norms. According to Sabatier, policy learning across belief systems is limited to secondary beliefs. The policy core can change as well, but not as an effect of learning. Rather, a perturbation in non-cognitive factors external to the policy area (for example, a shock in the policy environment which alters the balance of resources between adversarial coalitions) is the trigger of change in policy core beliefs. As major policy change requires modification of the policy core, Sabatier concludes that cognitive factors are not likely to produce policy shift. However, the narrative examined in this study has been instrumental in altering (a) member states’ perceptions of the overall seriousness of tax competition and (b) their view of the level of government (national or EU) at which the problem of tax competition should be tackled. Thus it seems that cognitive factors such as policy narratives can modify the policy core beliefs and hence lead to policy change. In this respect, policy narratives represent an excellent tool for examining the dynamics of belief systems.

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The second point concerns the stability of coalitions. The Archimedean lever of Sabatier’s approach is that coalitions provide the backbone of the policy process. There can be two or more advocacy coalitions, but ultimately policy change will materialise from what advocacy coalitions do. Coalitions can fight, learn from each other, expand their membership, but the boundaries between one coalition and the other(s) cannot evaporate. The case of EU direct tax policy is intriguing in this respect as it shows how the Commission has deliberately sought to enfeeble the boundaries of two opposing coalitions. Indeed, the Commission has tried to steer the direct tax policy process towards a different structure, based on a decreasing importance of advocacy coalitions and on more integration amongst actors. It is as if the Commission intended to break down the walls between one coalition and another. The crucial element in this strategy has been a policy narrative, precisely the narrative of tax competition.

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This raises the following questions:

• What are the political implications of policy narratives in terms of policy core beliefs and interaction between coalitions?

• What are the mechanisms leading from the adoption of a narrative to policy change?

• What is the theoretical scope for the integration of ideational variables within more structured approaches to policy change, such as the advocacy coalition approach?

• How can the study of policy narratives inform the discussion on supra-national agency and the debate on structure and agency in European public policy? This paper proceeds in three steps. Section two provides background information and examines the political construction of the narrative of tax competition1. A key argument in section two is that the tax competition narrative has been accompanied by a broader attempt to re-invent the Commission as a tax policy forum. This link between policy narratives and organisational change explains the profound political impact of the tax competition narrative. Section three investigates the political consequences ensuing from the adoption of the tax competition narrative. The impact of this narrative on advocacy coalitions and policy change is the main object of study in this section. Finally, section four provides - somewhat speculatively - insights for further theoretical advance on the role of knowledge in policy-making.

1 Methodologically, the narrative has been examined by using official documents, the press and thirty in-depth semi-structured interviews with policy makers operating in Brussels (Commission and European Parliament) and in member states (Belgium, France, Germany, Italy, Luxembourg and the UK). Supplementary interviews at the OECD and the US Treasury have provided the wider context of the politics of tax globalisation.

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2. BUILDING THE POLICY NARRATIVE

'Jihe direct tax policy of the European Union: ‘embryonic’ or simply irrelevant?

The coordination of direct taxes in Europe has been the object of a series of proposals put forward by the Commission since the early 1960s (Easson 1992). Notwithstanding the proliferation of studies showing the inefficiencies of uncoordinated tax systems and concrete suggestions for European tax policy, until recently the state of the play was well described by the pessimism of Advocate-General Léger, who stated laconically that ‘unlike value added tax, direct taxation is at a purely embryonic stage of harmonisation’2.

Indeed, up until the 1980s, the results achieved in tax co-ordination were

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poor. Perhaps the most important result in direct taxation was a directive on collaboration amongst tax authorities agreed in 1977 (no.99/77/EEC), and even in this case the implementation of the directive was far from being satisfactory. Learning from this disappointing record, when Commissioner Christiane Scrivener took the portfolio for tax policy in 1989 the strategy of tax neutrality , was launched. The aims of this approach to tax co-ordination were to present direct tax proposals as a ‘natural’ complement to the single market design, and to adhere completely to the cautious, technical, aseptic language of efficiency and tax neutrality. Essentially, the Commission withdrew grandiose proposals for a common corporate tax system and attacked domestic taxes - such as cross-border withholding taxes on the operations of multinationals - hampering free trade and irtyestment in the single market. The idea was that European tax policy should be limited to the removal of this type of domestic taxes, to be assessed on a case-by- case basis, thus providing a level playing tax field to corporations operating in the single market.

The Commission found itself in good company with economists arguing that tax differehces between member states are acceptable, as long as they do not create prejudice to neutrality. Tax diversity would be considered generally acceptable because results from different choices about the role of the state in the economy and the welfare state in countries which remain diverse. However, there are domestic taxes (for example, a withholding tax on dividends paid by a subsidiary to a parent company in another state) which are not neutral (i.e., they distort) to the multinational choices of corporations. Investment decisions should not be distorted by international double taxation of profits and cross-border

2 Quoted by Hinnekens (1997,31). © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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payments of interest and royalties within multinationals. The tax system should remain neutral in this respect and European action should secure this policy goal.

This strategy was appealing to economists (because of the emphasis on efficient tax systems and tax neutrality), to companies (the removal of international double taxation is a long-standing European policy goal of employers and their federations) and of course to the Commission (suffice it to mention the implications of the strategy for the single market). As shown in another study (Radaelli 1997), a ‘supra-national’ coalition, composed of the Commission, experts with policy-relevant knowledge and corporate actors emerged. However, an alternative ‘inter-govemmentalist’ coalition, recruiting its members across ministers of finance and revenue authorities, was less than willing to make generous concessions. Two directives were adopted by the Council in 1990, on corporate taxation, together with a convention on arbitration in international tax controversies regarding transfer pricing policies of multinational companies3. But progress did not go much further.

One consequence of the articulation of the EU tax policy process in terms of advocacy coalitions is the adversarial nature of policy-making. One coalition tends to dominate the policy sub-system, and the other coalition, in a manner of speaking, remains in opposition. As the EU tax policy process has been traditionally dominated by the ‘inter-governmental’ coalition, it not surprising that member states conceded only embryonic degrees of Europeanisation. Cooperation between the two coalitions became an unattainable goal, so much so that even very specific directives proposed by the Commission with the support of European multinationals were not approved by the Council. Year after year, direct tax policy turned into an argument with very low political salience. Notwithstanding the technical elaboration of the proposed directives, politically member states were not interested in making tax concessions at the European table. A period of scarce interaction between the Commission and the Council, and a general lack of political attention, ensued. When Professor Mario Monti took the single market portfolio in 1995, there were 18 tax proposals at the Council’s table, but a higher number of proposals (30) had been withdrawn.

In his attempt to re-gain momentum for EU taxation, the new Commissioner deliberately placed tax issues within a broader political 3 The European direct tax instruments agreed in 1990 are the following ones, directive 90/435/EEC on parent subsidiaries, directive 90/434/EEC on European mergers and acquisitions. The convention on transfer pricing completes the 1990 directives but because of its nature (a convention among states, not a Council’s directive) is not enforced by the Commission, and neither is it reviewed by the European Court of Justice. On the these tax instruments see Easson (1993).

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framework. The starting point was a reflection document presented to the informal ECOFIN meeting of Verona during the Italian Presidency of the EU (13 April 1996). The Verona paper4 argues that ‘in the past too often discussions were confined to taxation proposals seen in isolation, thus limiting proper consideration of wider tax issues and of the framing of taxation policy within the wider context of EU policies’ (emphasis added).

It is interesting to observe the use of the term ‘frame’ by the Commission. Indeed, the new approach of Commissioner Monti has been precisely an attempt to re-frame tax policy. Once the subject for technical debates with low political salience, tax policy has been purposefully inserted into a much more politically relevant frame. There are two key elements in this re-framing exercise:

a) the narrative of tax competition based upon a ‘comprehensive approach’ (as opposed to the previous strategy of tax neutrality and punctual proposals); b) the re-invention of the European Commission as a tax policy forum.

An important political consequence has been - at least so far - a more cooperative attitude of member states toward tax coordination, culminated with the adoption of a code of conduct and precise commitments on tax-related state aid rules and capital income taxation (December 1997). By re-presenting itself not as a component of an advocacy coalition, but as a forum for inter governmental deliberation, the Commission has curbed adversarial politics and created the pre-conditions for problem-solving politics5. In the remainder of this section we will first turn our attention to the politics of re-framing and then to the re-invention of the Commission as a policy forum, leaving to the next section the discussion of the political implications of these events.

Getting the rhetorical momentum: the narrative of tax competition and the re-framing of EU direct tax policy

The Verona paper introduces an important innovation in the frame adopted by the Commission for interpreting tax policy and making proposals. In fact, somewhat surprisingly, the paper states that the main challenges for EU taxation policy are to be found outside taxation itself. The argument of the Commission is that these challenges relate to three goals, namely employment policy, the smooth functioning of the single market, and the stabilisation of the member states’ tax revenue. It is easy to see the link between tax coordination and the stabilisation of

4 The title of the paper is Taxation in the European Union, SEC(96) 487 final, 20 March 1996. 5 In more rigorous terms, I refer to the difference between a confrontational decision style and a problem-solving style postulated by Scharpf (1989).

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revenue in member states, that is, the third goal. But how can direct tax policy - in the past framed in terms of selective measures against the tax distortions incurred by multinationals - be re-framed as the cement of the single market and EU employment policy? The mechanism enabling this fundamental shift of political emphasis is the narrative of tax competition, whose causal components are synthesised in figure 1.

Figure one. The narrative of harmful tax competition

- Progress of negative integration through the Single European Act______________ - Capital is mobile and capital flows are liberalised____________________________ - Lack of positive integration______________________________________________

Taxation is not coordinate, special tax regimes are not controlled by EU policy Tax base erosion_______________________________________________________ Tax burden placed onto non mobile factors, typically labour___________________ Doomsday scenario. What happens if we do not act together, Crisis of the welfare state__________________________________________________________________ - The lack of tax coordination is damaging the edifice of the single market________ The lack of tax coordination aggravates the problem of unemployment in Europe Unemployment and the single market are at the core of EU problems___________ New and comprehensive view of taxation in the EU is needed_________________ Tax policy becomes a core policy of the EU________________________________

Tax competition is a variant of regulatory competition. Studies on regulatory competition show that the ‘competition of rules’ among countries is open to very different results, depending on the socio-political amalgam of politics, ideas and interests (Vogel 1995; Sun and Pelkmans 1995). Theoretically, there is the possibility that countries will suffer from a disastrous race to the bottom, but under certain political conditions the process can end up with a levelling up of rules and standards. In the jargon popular since David Vogel’s book appeared (1995) the two possible outcomes are the Delaware effect (the race to the bottom) and the California effect (trading up)6.

Turning to tax policy, the literature contains examples both of optimistic assessment of tax competition (McLure 1985; Siebert and Koop 1993) and pessimistic predictions of unbridled tax competition eroding the tax base (Sinn 1990). An analysis of the alternative arguments for and against tax competition is beyond the scope of this study. It is sufficient to observe, nevertheless, that the 6 On the dynamics of tax competition within the more general framework of regulatory competition see Genschel and Plumper (1997).

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Commission has never questioned the possibility that a certain degree of tax competition stimulates efficiency and punishes the profligacy of politicians. At the same time, since the Verona paper the Commission has argued persistently that certain characteristics of current tax policies are triggering the mechanism of harmful tax competition. When is tax competition harmful? The narrative proceeds from the acknowledgement that significant progress has been made - via the Single European Act - in negative integration. Barriers and distortions in the single market have been progressively removed and this has inter alia constrained national policy choices. Following the liberalisation of capital flows, for example, governments can no longer limit cross-border capital flows within the EU. At the same time, positive integration (that is, EU-wide social policy, progressive taxation and redistribution) is stymied at the Council level (Scharpf 1996, 1997). Moreover, the lack of a real EU tax regime leaves states free to offer special tax regimes which attract the most mobile factors, typically capital and, perhaps, skilled labour (Tanzi 1995). The existence of non location-specific activities has made central services of companies, head offices, offshore banking and captive insurance companies free to go where the tax regimes are more favourable. A consequence is that countries unwilling or unable7 to play the game of special tax regimes and tax concessions are penalised in terms of significant erosion of the tax base. More importantly still, countries would have to tax labour more heavily, should capital migrate elsewhere.

The next step in the construction of the narrative is the climax reached through the doomsday scenario. If EU countries do not act together - the story goes on - a political time bomb will disintegrate the welfare state. Capital income taxes will spiral down to zero, corporations will move profits to special tax regimes, and governments will be left with the sole option of asking for more revenue from low skilled labour. With the passing of time, redistributive policies and the whole mechanism of the welfare state will come to a grinding halt.

After the doomsday scenario, the story turns to the present and stresses the implications for the single market and for unemployment in Europe. The effectiveness of the single market is endangered by the presence of tax rules camouflaged under legitimate state aid, and policies against unemployment are nullified by the shift of the tax burden towards labour. The lesson of the story is that tax coordination is a fundamental bulwark of the single market and employment. Without it, the edifice of the single market will cave in soon and ambitious programs such as the Confidence Pact for Employment will remain dreams of an unattainable future. The political attention for tax coordination - this

7 Domestic veto players can hinder tax policy change and thus decrease the competitiveness of a state in the tax competition game. See Hallerberg and Basinger (forthcoming).

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is an explicit impact sought by the narrative - must be raised to maximum levels. In the old strategy of tax neutrality, European direct taxation was a policy in search of a ‘drive’. At that time, the single market was chosen as the drive that - according to the Commission - could have assisted the launch of EU tax coordination. With the narrative of harmful tax competition, instead, EU tax policy becomes itself an important drive to the rescue of the welfare state and employment.

How much scientific analysis lies behind this narrative? There are good reasons for raising doubts about the doomsday scenario. Recent economic literature (Gordon and Bovenberg 1996), for example, posits that capital does not move freely from one country to another because of asymmetries of information and uncertainty. Firms and capital owners do not rapidly exit from a country when tax rates abroad fall. Their knowledge of local conditions in foreign markets is far from being complete and sunk costs cannot be recouped quickly. Empirically, capital income taxes have not as yet fallen to zero and statutory corporate tax rates are still high. In Europe, moreover, they are systematically higher than in the US or in Japan.

Even if one assumes that tax competition yields a drastic reduction of capital taxation, the effects of lower taxes on capital are uncertain (Zee 1996,8). True, in the short-term, a tax competition-induced reduction of the rental price of capital affects labour negatively, the magnitude of this effect depending on the elasticity of substitution between capital and labour. However, in the long run investment has a favourable impact on the economy and employment can rise again (Zee 1996). Additionally, skilled labour is not a substitute for capital, but a complementary factor. Therefore, lower taxes on capital can stimulate the demand for skilled labour and, in the long run, encourage the formation of human capital. Ultimately, the impact of tax competition on employment hinges on the trade-off between short-term losses and possible long-term gains.

One option available to the Commission, therefore, could have been to engage in the production of empirical information. In the past the Commission relied on heavyweight committees of experts to buttress its tax proposals, but not this time. The last exercise in the production of tax policy-oriented information was the Ruding Committee (Commission 1992), but in that event the Commission noted that ‘owing to lack of reliable statistical information, the Committee was unable to judge whether or not such competition would lead to considerable erosion of tax receipts’8. In synthesis, the Commission does not have much

8 Communication of the Commission, SEC(92) 1118, 27 July 1992.

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empirical evidence at its disposal9. But instead of investing in scientific expertise. Commissioner Monti has stressed the political determination to act. What is sufficient for action is the concern among member states that the effects of fiscal erosion could ultimately wreck Community goals such as the single market and employment policies. If countries are convinced that the risk of the doomsday scenario is realistic - the narrative concludes - action must be taken now.

The literature on policy narratives is useful here because it argues that scientific uncertainty is translated into political certainty by the use of dominant stories in the policy process (Garvin and Eyles 1997). One of the key functions played by the narrative of harmful tax competition is the stabilisation of assumptions needed for action in a policy area dominated by genuine complexity and uncertainty. For the Commission it is more important to achieve the ‘rhetorical momentum’ than to produce yet another study on taxation. In the EU policy process, a rhetorical momentum is reached when member states and EU institutions begin to use ‘a common language with its own specific terminology, persuasive logic and teleological assumptions’ (Trimingham 1997,4). A rhetorical momentum is relatively independent from the presence of ‘hard’ empirical evidence, as explained by Yee (1996,95): ‘Once particular arguments and phraseology have been deployed, a “rhetorical momentum” is generated which operates independently to affect policies’ (Yee 1996,95).

Those who fight against the rhetorical momentum run the risk of telling, in Roe’s (1994) terms, a non-story. The narrative of harmless and beneficial tax competition merely argues that under capital mobility markets clear efficiently, the Leviathan is tamed, and ultimately everything under the (market)-sun is fine. Notwithstanding the noble pedigree provided by public choice, currently the advocates of tax competition are on the defensive in the European Union policy process. Academically they still command respect, but in the EU tax policy discourse they have not gained prominence. One reason for this, perhaps, is that their non-story does not portray increasing control over events and therefore is not very compelling (Stone 1988). Public policy is all about making problems amenable to human action, not about increasing helplessness (Garvin and Eyles 1997). By contrast, the story of tax competition stresses human control over 9 So far the Commission has relied on raw Eurostat data. The most recent figures show that in

1995 the EU raised 51.4 per cent o f total tax receipts on employed labour, compared with 43.2 per cent for the EU (six members) in 1970 (Eurostat, Labour Taxation in the European Union). A recent paper commissioned by the World Bank has found empirical evidence of tax- induced unemployment in the European Union (Daveri and Tabellini 1997). See also Zee (1996) and Sorensen (1997) for a discussion of taxation, unemployment and possible tax reforms. Sorensen observes that the impact of tax reforms on employment levels hinges on crucial assumptions related to the structure of the labour market.

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harmful tax competition. It is also convincing in narrative terms. In fact, it plays out a vivid dramatic scene of villains (avid capitalists who deprive their countries of revenue by investing in morally suspect tax havens), potential victims (the ordinary people who need the welfare state) and heroes (the European governments who decide to take action and protect the welfare state)10.

The narrative of harmful tax competition has also an important political property. It ‘talks’ directly to member states by raising problems of revenue and the political problems of the welfare state and employment. Put differently, this narrative magnifies the economic and political gains available to states through European cooperation. By contrast, the approach of tax neutrality adopted by the Commission in the past - based on the selective elimination of domestic taxes hampering the growth of genuine multinational companies in Europe - highlighted gains to be reaped by companies and costs to be borne by states. It can be observed that the discourse of tax neutrality pursued in the early 1990s by Commissioner Scrivener revolved around the idea that specific domestic taxes on cross-border activities of multinationals had to be eliminated in order to gain efficiency. This is an example of what Scharpf (1996) calls ‘negative’ integration, that is, market-making policy. The core idea is to strike down national rules that impede the smooth functioning of the single market. The harmful tax competition narrative is instead an example of ‘positive’ integration or market-shaping policy. Once a single market has been ‘created’ with capital movement liberalisation, ‘positive’ action must be taken in order to avoid the undesirable consequences of market behaviour.

Further, tax competition rings a political bell in those countries where the existence of domestic veto players obstacles tax reforms at the national level (Hallerberg and Basinger, forthcoming). The case of Germany, where Chancellor Kohl has been unable to respond with effective domestic tax reform to the challenge of tax competition, epitomises the appeal of EU solutions when veto players impede domestic policy change. In a sense, one element of success of a political narrative in the EU policy process is its appeal in terms of member states’ priorities. The difference between the old discourse of neutrality and the new narrative is portrayed in figure two below. In this figure, I make the heroic assumption that member states have similar preferences, although there are strong distributional conflicts between, say, Luxembourg and Germany. However, at this stage it is important to shed light on the different advantages for companies and countries. I will consider distributional conflicts among states below.

10 I borrow this language from Garvin and Eyles (1997,65).

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Turning to figure two, it should be observed that, at least in the long term, both tax neutrality and the new approach of tax competition are ways of securing collective gains. But in the short term the immediate impact of the rhetoric of tax competition is the closure of tax havens and special tax concessions (a gain for member states in terms on revenue stabilisation, but a loss for companies benefiting from special tax rules). By contrast, the immediate impact of tax neutrality is an advantage for companies and a cost for revenue authorities, compelled to give up withholding taxes. Webb makes a similar point when he observes that the activity of the EU in corporate taxation up to the early 1990s was ‘overwhelmingly oriented towards eliminating double taxation, not to increasing the ability of governments to raise revenues from corporate taxation’ (Webb 1996,24).

Figure two. Costs and gains of different approaches to EU tax coordination

Gains of tax coordination

Costs of tax coordination Gains for countries Gains for companies

Costs borne by countries Tax neutrality (1989-1994)

Costs borne by companies Tax competition narrative (1995-1998)

Finally, it should be observed that narratives are politically revealing for what they do not say. As known, agenda setters seek to exclude issues from the decision-making process. Keeping an issue off the agenda is as much as important as it is placing an issue onto the agenda (Bachrach and Baratz 1962). Turning to EU taxation, it should be observed that the narrative of tax competition has been constructed in such a way as to exclude the intersection of tax policy with the Economic and Monetary Union. Hundreds of pages have been written on the fiscal implications of monetary unions, but so far Commissioner Monti has defended the idea that taxation is a single market issue, and as such is separate from the single currency. There are two reasons for this decision to keep the single currency off the agenda. One is that the single currency follows the

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path of flexible integration. Eleven countries gave birth to a monetary union in Europe, but other members of the EU will keep their own currencies. It is not easy to apply the logic of flexible integration to tax policy. A Union with fiscal ins and fiscal outs runs the risk of institutionalising the tax barriers to trade, with the perspective of turning the single market into a jigsaw. A two-speed Europe can make sense in monetary policy, but perhaps not in tax policy.

However, there is also a non-trivial intra-organisational reason for keeping monetary and tax issues as much apart as possible. Taxes and monetary policy belong to two different Commissioners who seek to protect their portfolios jealously. It is not a mystery that Commissioner De Silguy, in charge of monetary policy, is relatively keen on broadening the single currency agenda in order to accommodate taxation within it. So much so that he had already prepared a study on tax policy under the single currency". Due to the angry reactions of Commissioner Monti, the study was shelved promptly. But this episode is indicative of the fight for the control of the tax policy agenda within the Commission. The boundaries of the narrative, in conclusion, are marked by political power.

Re-inventing the Commission as policy forum

Schon and Rein (1994) observe that frames are not free floating but are grounded in institutions. A narrative gains political power only when rooted in institutions: for example, by means of appropriate organisational change able to sustain the adoption of a new frame. There is an important relationship between the adoption of a new frame, organisational change, and political dynamics. In the case under examination, the narrative of harmful tax competition has sustained the attempt to attenuate the elements of adversarial policy-making in the EU direct tax policy process. The idea of re-proposing the Commission as a tax policy forum rather than as the leader of the supra-national coalition has been crucial in this strategy. An appropriate organisational change (that is, the creation of a high level group on EU tax policy) has buttressed this strategy of policy change11 12.

In the aftermath of the Verona paper, which rekindled attention on EU direct tax policy after years of political wilderness, the Commission suggested 11 See Financial Times 13 March 1997, 'De Silguy drops study on tax harmonisation’, the weekly European Voice, 23-29 January 1997, ‘De Silguy warns of two-speed EMU risk’ and

Agence Europe no.6895, 18 January 1997 ‘Reinforced cooperation will not concern single

currency and no fiscal harmonisation planned for income tax’.

12 See Christiansen (1997) on how the Commission can switch between a supra-national mode and an inter-governmental policy forum.

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member states give birth to a tax policy group composed of personal representatives of EU ministers of finance (and chaired by the Commission). Since the beginning, this has been a high level group and not just one of the many technical working groups active within the Commission. Member states bought the idea13 because the composition of the group was such that there was no apparent risk of giving agenda setting powers to the Commission. The latter, however, was not excluded from this inter-governmental forum because it was up to the Commission to chair the meetings and provide a secretariat. Additionally, the Commission drafted the report of the group14. Therefore the Commission was always in a position from which it was not difficult to provide inputs to the group. One crucial political result was indeed achieved by Commissioner Monti, that is, to break the ice of adversarial politics separating the Commission from member states in direct tax policy.

The mandate of the tax group was to take a comprehensive view of taxation policy in the EU. Hence the past strategy of case-by-case approach was shunned definitively and the policy discourse was re-directed towards ‘comprehensive’ (as opposed to piecemeal) tax policy. In the report of the tax policy group, presented by the Commission in October 1996, the single market, employment and taxation were melded firmly by the narrative of tax competition. At that stage, not all member states were convinced of the need to take one precise form of action instead of another, but political attention was definitively drawn to the existence of ‘unfair’ tax practices, thus placing tax competition at the centre of the tax policy debate. The report recommended further work on the definition of ‘unfair’ tax competition and on possible initiatives, ‘whether legislative or not’. With the report, the Commission secured a result in terms of political commitment to go ahead with proposals. However, consensus on the new role of the Commission as tax policy forum was not alienated by the presence of ‘hard’ legislative proposals. Quite the opposite, indeed, one of the key ideas aired at the group was the examination of ‘soft’ voluntary policy instruments.

13 The ECOFIN ministers appointed personal representatives to the high level group, which met four times, on 24 June, 19 July, 12 September and 7 October 1996.

14 European Commission, Taxation in the European Union, Report on the Development o f Tax

Systems, COM(96) 546 final, Brussels, 22 October 1997.

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Having achieved rhetorical momentum and political attention, action has to emerge from strong political determination. Accordingly, following the publication of the report, the Commission has sought to intensify the politicisation of the process. Meeting in Brussels on 11 November 1996, the ECOF1N ministers decided to pursue their discussion in the context of a standing group on taxation where all members would have higher political status. Thus the previous tax policy group continued with a few crucial changes of membership. Finland, France, the Netherlands and Spain appointed higher political level representatives, to denote the determination to seek consensus politically beyond technical difficulties. To put it simply, some of the previous personal representatives were substituted by more political representatives. To give an idea, in 1997 the ‘new’ tax policy group had amongst its members MEPs, secretary generals of some ministries of finance, under-secretaries of state for finance, and, in the case of Luxembourg, the Minister for the Budget, Mr Marc Fishbach. Commissioner Monti was left to chair the group, but occasionally, in the second half of 1997, when negotiations became closer to a deal, Mr Fishbach chaired directly in his capacity of finance minister of the country holding the six- month presidency of the EU.

It was precisely during the Luxembourg presidency of the EU that a final deal was clinched on 1 December 1997. The bargaining process leading to the deal revealed the conflicts implicit within the narrative of tax competition. As observed above, a fundamental political property of this narrative is the shifting of the discourse towards the revenue priorities of member states, at the cost of a minor emphasis on multinationals and their problems of double taxation (see figure two above). But once accepted, the narrative has other political implications. For a deal to be struck, conflicts between different countries have to be settled. Member states do not have the same structure of preferences in the EU direct tax policy process. Ireland and Belgium, for example, are very attractive locations for foreign companies, given the ten per cent corporate tax rate of Dublin Docks and the fiscal advantages provided by coordination centres in Belgium. By contrast, Luxembourg has developed a relative specialisation in attracting savings. In other words, Ireland and Belgium are very competitive in corporate taxation, whereas Luxembourg is competitive in capital income tax. To make things worse, small countries can benefit from tax competition disproportionately, and conversely large countries bear the brunt of unbridled tax competition15.

15 This is a general result of the political economy of tax competition. See the classic Kanbur and Keen (1993). © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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In the tax policy group these divergent interests were pitched one against the other. Two resources were at hand for solving the conflicts, however. One was the politicisation of the tax policy group. This made it easier to strike political deals when the political advantage of coming to an agreement was greater than the economic cost of renouncing to a certain tax scheme. The examples of Luxembourg and Germany provide interesting insights. For Luxembourg, reputation and prestige were important political objectives. In the past, Luxembourg had not hesitated to veto single proposals for tax coordination against the will of all the other states, but in the context of a high profile political negotiation pressure to coordinate was greater, and so were the reputational costs of rocking the boat. For Germany, tax coordination at the EU level was indispensable giving the failure of tax reform at home and all political energy was put behind the initiatives of the tax policy group.

The second resource was the comprehensive approach implicit in the narrative of tax competition. This transformed a series of individual zero sum games into a larger positive sum game. By considering tax policy comprehensively, countries losing on one specific tax policy issue were compensated by gains in other issues. To put it differently, the package deal approach facilitated agreement and put pressure on reluctant countries. For example, within the Benelux countries Belgium - under attack for the coordination centres - put pressure on Luxembourg when taxation of savings was on the agenda, and, in turn, Luxembourg insisted for a deal inclusive of business taxation, and not limited to the taxation of savings.

Unsurprisingly then, the agreement reached on 1 December 1997 included four elements16. The first was a voluntary code of conduct in business taxation. Over the period of five years, the code of conduct should provide initially a standstill on special tax regimes, and later a rollback of tax measures. The code defines at a very general level what damaging tax measures are without blacklisting any particular tax regime. It is interesting to observe that the code does not use the expression ‘unfair’ tax competition, although this term had been aired at the first meetings of the tax policy group. Instead, emphasis has been put on what produces ‘damage’, thus fending off the more sensitive question of whether certain tax decisions are fair or unfair.

Turning to capital income taxation, the second component of the deal was the commitment to ensure a minimum of effective taxation of savings within the Community. The Council requested the Commission to come up with a proposal

16 See Council conclusions on fiscal package, as published by Agence Europe, no.2061, 3 December 1997. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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for a directive and set a few points around which the proposal should be fleshed out. Following this invitation, the Commission presented a proposal for a 20 per cent withholding tax on interests paid to non-resident EU citizens in May 199817.

The third element was the decision to take a closer look at state aid policy, and accordingly the Commissioner for competition Karel Van Miert was requested to draft clear guidelines on those state aids which employ taxes as the main policy instruments. Special tax regimes have too often been built under the rubric of legitimate state aid policy, thus circumventing the scrutiny of the tax Directorates of the Commission. Finally, the fourth element of the ECOFIN deal was the decision to resume proposals for a corporate tax directive on interest and royalty payments across borders. The Commission had already put forward proposals for a directive on this issue, but the lack of political commitment and technical problems had led Commissioner Scrivener to withdraw the proposed directive in 1994. Therefore the Commission prepared a new proposal, formally submitted to the Council in March 199818.

3. FROM POLICY NARRATIVES TO THE POLITICS OF NARRATIVES

Do narratives trigger policy development? The case under examination shows that narratives are related to broader political dynamics. The tax competition narrative does not operate in a political vacuum, but is linked to strategies of organisational change (that is, re-inventing the Commission as a tax policy forum) and to an incisive political commitment to come to an agreement within ECOFIN. Having said that, there are four implications of the tax competition narrative for policy development.

To begin with, as the Financial Times put it, ‘fiscal policy has emerged from a long spell in hibernation’ (31 January 1997). Continuity over time is the first, albeit minimal, result achieved by the new strategy pursued by Commissioner Monti. A policy that was hardly noticeable, characterised by a handful of directives, is now on track. Since the Verona paper, political attention

11 Proposal for a Council directive to ensure a minimum of effective taxation of savings income in the form of interest payments within the Community, COM (1998) 295, 20 May 1998. Member states can choose between the 20 per cent withholding tax and exchange of information on non-resident savings.

18 Proposal for a Council directive on a common system of taxation applicable to interest and royalty payments made between associated companies of different member states, COM (1998) 67 final, 4 March 1998. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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has been constant and there are no signs that the momentum will be lost in the near future.

The second implication of the narrative is task expansion. Tax policy negotiations have moved from isolated discussions of single directives to macro political discourse. Moreover, with its emphasis on tax competition, the EU has now reached an even wider political debate. In fact, both the OECD (1998) and the G719 are currently working on this issue.

Related to task expansion is the third implication, that is, the shift of tax policy towards the core of EU public policy20. A few key episodes and a cursory look at EU strategic documents, illustrate how tax policy, once at the periphery of the EU, is now firmly situated at the very core of EU public policy.

- The Dublin European Council (13 and 14 December 1996) ‘welcomed the Commission’s intention to continue discussions in a tax policy group, paying particular intention to the effects of this policy on employment’21 22 23. For the Commission, this meant the acceptance of the tax competition narrative. The link between tax policy and unemployment postulated by the narrative was indeed accepted without hesitation by the European Council.

- The need for ‘a coherent overall tax policy at the Community level’ is included in the strategic document on The Impact and Effectiveness o f the

Single Market22. This means acceptance of the link between tax policy and the

wider single market strategy.

- The Action Plan fo r the Single Market23 highlights the removal of tax distortions as a key strategic target for improving the performance of the single market. The [flan recommends the adoption of a code of conduct ‘designed to reduce effectively harmful tax competition’, the elimination of distortions in capital income taxation, and measures against the double taxation of cross-border activity of companies, with particular emphasis on the taxation of interests and royalty payments between companies.

19 In June 1996, the leaders of the G7 expressed their concern for harmful tax competilion in terms of tax-induced distortions to trade and investment and erosion of countries’ ability to collect revenue. The negative impact of taxes on employment was discussed by the G7 meeting dedicated to jobs and labour standards (Lille, April 1996).

20 See Majone (1989) for the notion of policy core, as opposed to the periphery of public policy.

21 European Council, Dublin, 13 and 14 December 1996, Presidency Conclusions. 22 COM(96) 520 final, 30 October 1996, page 31.

23 Commission CSE97-1, final, 4 June 1997, see page 5 and 6.

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- At the Amsterdam European Council (16 and 17 June 1997) a resolution on growth and employment was agreed. Employment policy was linked explicitly to tax policy, not only by requesting more ‘employment friendly’ tax and social protection systems, but also by adding that ‘the European Council has agreed concrete action on making maximum progress with the final completion of the internal market: making the rules more effective, dealing with the key remaining market distortions, avoiding harmful tax competition,

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- In an interview with Der Spiegel (no.33, August 1997), the German Finance Minister Theo Waigel lambasted the presence of tax havens in the EU, and compared the recent establishment of the Triest port in Italy24 25 as a special tax regime to the notorious Dublin docks in Ireland26. A row followed, in which the Italian press portrayed a German gambit to attack tax havens in other EU countries with the hidden agenda of getting concessions for special tax regimes in their own ports of the North27. Commissioner Monti, designated by the Italian government, defused the row by refusing to take sides in the journalistic controversy and arguing that the concerns raised by the German government were yet another stimulus to go ahead with cooperative decisions at the European level28. Accordingly, he demanded the full backing of the German government during the discussion of the EU code of conduct. The row imploded, with the Commission cashing the dividend of having placed the code of conduct in the limelight of the public discussion, at least in Germany and Italy.

- At its extraordinary meeting on employment (Luxembourg, 20 and 21 November 1997) the European Council ‘confirmed the need to reverse the trend towards increasing the tax burden and stressed in this context the importance of coordinated action by Member States’. The summit recalled its concern ‘to bring to an end unfair tax competition liable to harm employment’29. During the preparation of the summit, the European 24 See the Resolution of the European Council on Growth and Employment, annex to the Amsterdam European Council of 16 and 17 June 1997, Presidency Council.

25 The decision was published in Official Journal L 264, 7 November 1995, at p.30.

26 Precisely, Waigel struck out against the decision to allow ‘Dublin, for example, or Triest to establish low tax zones’.

21 On 10 August 1997, the Italian daily Corriere della Sera published an interview with the president of the Chamber of Commerce in Triest, where he denounced the tactical behaviour of the German government, accused of planning the transformation of some ports in the North of Germany into off-shore centres.

28 See the interview with Monti published by Corriere della Sera, 12 August 1997.

29 Presidency Conclusions, as published by Agence Europe Documents, no.2059, 26 November 1997. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.