Despite the Prime Minister Tony Blair's backing from France and Germany, EU leaders failed to achieve the unanimity needed to delay the abolition of duty free which is due to take place next summer. The Netherlands, Denmark and Belgium all held out.
However, British officials retained the hope of keeping the issue alive by including a reference to duty free in the summit conclusions which will be drawn up today.
Meanwhile, divisions over the European Union's multi-billion pound budget increased yesterday, as blunt demands for a cut in German contributions and a British refusal to negotiate on its own rebate threatened to throw the EU's enlargement programme into crisis.
Amid few signs of compromise, Germany's Foreign Minister, Joschka Fischer, warned that financial reforms were an "essential condition" for expansion. Germany stepped up pressure on Britain's pounds 2bn annual rebate. The Chancellor, Gerhard Schroder, said: "All options have to be considered."
He was backed by the French President, Jacques Chirac, who said there should be "no taboos", while the Premier of Sweden, Goran Persson, said now that the "Marg-aret Thatcher age was over", it was time for Britain to pay its share. But Mr Blair insisted it was "not negotiable" because the level of reform of the Common Agricultural Policy would not be enough to compensate for Britain's contribution.
Britain's rebate, worth on average pounds 2bn a year, was negotiated by Baroness Thatcher in 1984, but Germany, the Netherlands, Sweden and Austria say they are in a worse predicament than Britain was in the mid-Eighties. The Austrian presidency is pressing leaders to agree to a March deadline for the resolution of the budget question. Mr Schroder has used blunt language to demand a cut in Bonn's 22bn mark (pounds 8bn) net annual EU budget contribution.
Although at odds on the issue of the British rebate, London and Bonn agree on the need to freeze EU spending at its current level, plus inflation, for the years 2000-2006. That is fiercely opposed by big beneficiaries of structural and cohesion funds, including Spain, whose Secretary of State for European Affairs, Ramon de Miguel, said he did not recognise Germany's call for a cut in its net contribution. "It's like a 20th-century Robin Hood, but in reverse," he said.
The European Commission has estimated the cost of enlargement, which will bring up to a dozen Central and Eastern European countries into the Union will exceed $50bn.
Mr Schroder stepped up the pressure for British concessions on the controversial withholding tax on savings, arguing that moves to tackle unfair tax competition should be speeded up and resolved in the first half of next year, during Germany's presidency of the EU.
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