Leading Article: This EU tax row shows the cost of Euroscepticism

THE LEGACY of decades of paranoid scepticism about the European Union will overshadow Britain's relations with our partners for a long time. Hostilities between Them and Us over beef are no sooner settled than a row over withholding tax erupts, raising the political stakes at next month's Helsinki summit. Gordon Brown has said "non, non, non" once again to the proposal to tax interest income in the EU at source at a uniform 20 per cent. The solitary British veto stands in the way of a plan to which the other 14 have agreed.

The savings directive was conceived when John Major was sacrificing sensible EU politics to keeping his own party in one piece. British influence on the draft directive has been minimal. Not surprisingly, it does little to serve British interests.

The idea is to prevent EU citizens from evading domestic taxes on their interest income by investing in another member country. The classic evaders are individual German savers, who face higher taxes at home than in the rest of the Union. Unfortunately, the proposed EU-wide withholding tax would apply to the City of London's massive Eurobond market. Institutional investors account for 90 per cent of the 4,000bn euros' worth of international bonds, and London accounts for up to four-fifths of the market. Introducing a withholding tax would send this market to financial centres outside the EU, putting tens of thousands of jobs in the City at risk.

There is a reasonably simple solution to the problem. European tax authorities could pass each other information about interest paid to investors. But other member states, including Luxembourg, have blocked this proposal on the grounds of banking secrecy.

The Government now faces a dilemma. Protect valid British interests by vetoing a flawed tax directive, and see a further deterioration in the UK's clout in the EU; or pay the penalty for past official Euroscepticism by accepting a proposal that will do real harm to the City but help to restore Britain's communautaire credentials.

There is little doubt that the Government will opt for the former, as it should. But the withholding tax row is a crystal-clear lesson in the costs of drifting away from the EU on a tide of extremist scepticism and public indifference.