At a meeting of the cabinet committee on Europe, which met on Thursday, ministers agreed to dump the threat to veto tax harmonisation because they fear it will turn Britain into a marginal player.
Robin Cook, the Foreign Secretary, argued that the United Kingdom should be able to block any controversial proposals through consensus and by winning support from other countries, rather than by confrontation. He is wary of returning to the sort of rhetoric used by Margaret Thatcher and John Major during the previous Conservative administrations.
However, the decision amounts to an admission that the Government mishandled the tax issue last year when Gordon Brown, the Chancellor, threatened to use the veto to ensure that Brussels did not win control of tax policy.
Last night the Conservative party said it represented a "colossal U-turn" which left Britain open to taxes imposed from Brussels. "They promised the British people they would not go down the road of tax harmonisation, and now it appears that they will," a spokesman said.
Oskar Lafontaine, the German finance minister, is planning to use his country's presidency of the European Union, which lasts for the next six months, to push for closer integration of tax policy. A confidential Cabinet Office briefing paper, prepared for last week's Cabinet committee meeting, said company tax and withholding tax were the two areas which were likely to be the focus of attention during the German presidency.
Ministers are ready to sign up to a proposal to commission a study on the practicalities of unifying company tax policy across the EU, a sign that they are not opposed in principle to the idea of harmonisation in this area.
However, they are concerned about the proposal to harmonise "withholding tax" - which could lead to increased levies on savings invested in another EU country.
Mr Brown fears this could force the lucrative Eurobond market out of London to Zurich or New York where it would avoid the European tax.
Ministers agreed that they would seek to ensure that the Eurobond market was not affected by any proposals. But they decided that it would not be right to use - or even threaten to use - the veto to block Mr Lafontaine's plan. They will seek to win other member states over to their position instead. "Ministers do not think this is veto territory," one Whitehall source said. "There is no need to talk about vetoes if you are confident that there is good support around the table for your position."
The Cabinet committee also drew up a strategy for creating even closer ties with Germany. All ministers who deal with European issues will be ordered to meet their German counterpart before the end of February. They are being encouraged to set up bilateral working groups, similar to the committee on the Third Way which Peter Mandelson set up with the German minister Bodo Hombach.Reuse content