These grand ideas ignore a simple truth: Europe can't buck the market

The high-earning young move out, leaving an even greater burden on those who stay. The only way to keep them is to cut taxes
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The Independent Online

When economics and politics clash, economics usually wins. Whether or not the proposed European constitution means that Brussels will have a say over British taxes - and there is so much obfuscation that I don't think it is possible to know at this stage - economic pressures seem likely to push down Europe's taxes to UK levels, maybe beyond. The politics may be for higher taxes but the economics are for lower ones.

When economics and politics clash, economics usually wins. Whether or not the proposed European constitution means that Brussels will have a say over British taxes - and there is so much obfuscation that I don't think it is possible to know at this stage - economic pressures seem likely to push down Europe's taxes to UK levels, maybe beyond. The politics may be for higher taxes but the economics are for lower ones.

How so? Well, the pressure on governments across the whole of the continent will be huge for the next two generations. Government will be under tremendous pressure to spend more but also will find it harder and harder to raise revenue.

This is the result of the clash between two forces, demography and mobility. The first story can be told quickly. Continental Europe will become, after Japan, the oldest region in the world in terms of the proportion of people over the age of 65. The UK becomes older too, but at a rather slower rate. The effect of this is that, whereas there are currently just under three workers for every pensioner in Germany and France, in another decade there will be only two and a quarter. In 2050, when young people now entering the workforce are drawing their pensions, there will be fewer than one and a half workers for each pensioner. In Italy and Spain the ratios are even worse, for there will be more pensioners than workers by 2050. In the UK they are rather better: we are, as a country, getting older, but more slowly than the Continent.

European governments are well aware of the implications of these changing ratios on their finances for, not only will the bulging ranks of pensioners need their state pensions, they will also be a charge on health and care budgets. However governments find it hard to make even modest changes. The present bout of French strikes is one response to minor revisions to pension entitlements. If the protesters knew the extent to which their benefits would have to be cut, they would be rioting, not striking. The big fights are still to come - and if the pressure is serious in France it will be greater still in Germany, Italy and Spain.

If demography adds to the cost of government, mobility cuts its revenues. One form of revenue, company taxation, is already in serious decline, as corporations have started to move their activities to low-tax countries. For the winners this has been wonderful. Ireland has transformed its economy by attracting mainly US companies with tax holidays. It does not get revenue directly from the firms, but it does from the people they employ locally.

The next stage looks like being the movement of company headquarters. There have been examples of German companies moving to Switzerland and US ones to Bermuda. But the greatest gainer may well be the States, with this administration's new plans to cut tax on dividends. You can see why the European Union is anxious to have a reasonable measure of company tax harmonisation to stop Ireland scooping more than its share of Europe's pool of foreign investment. But the big game is not within Europe; it is between Europe and North America and it is hard to see much tax harmonisation there. For a firm such as DaimlerChrysler or GlaxoSmithKline, the legal headquarters could rationally be on either side of the Atlantic. If the tax advantages became big enough, they could move.

Over the past 10 years there has already been a sharp fall in company tax rates. This, I suspect, is a trend that has only just begun. Company taxes are, however, only a small proportion of government revenues. Here in Britain the rate is less than 8 per cent. The big money comes from income tax (including social security contributions) and consumption taxes, in particular VAT. So what matters is where people earn money, and where they spend it.

For the very rich, the choice of where to live is already very largely determined by tax. Tax havens including Monaco and the Channel Islands do a great business. There are people who live in the Channel Islands but work, in effect, a full week in London without, technically, ever being there for tax purposes.

Much more significant is the mobility of the young. You can see this best in London, which has become a magnet for young professionals from all over Europe and indeed North America. The South-east of England has the largest expatriate professional community on the globe. Continued professional inward migration is one of the reasons why the UN now expects the population of the UK to grow by 12 per cent over the next half-century. This compares with a rise of 8 per cent in France and falls of 4 per cent and 22 per cent in Germany and Italy.

Tax is not the only reason for professional mobility but it is a significant one. Young professionals are a hugely attractive proposition for any country. They bring skills, they create growth, they pay tax both on their income and their spending - and they are not big burdens on social security systems. I suspect that one of the main areas of competition within Europe will be for just these people and, of course, with the EU's single job market they are free to move anywhere.

If that is great for Britain, it is not so much fun for, say, Italy or Germany. The high-earning young move out, leaving an even greater burden on the taxpayers who stay. The only way to keep them will be to cut taxes. And the more the European economy becomes like the American one, the greater the mobility of labour. It follows that if Europe is to become a more dynamic economic region, the result will be population movements that force down tax levels everywhere.

You can see early signs of this already. In Sweden, the highest-taxed country in the world, spending has already fallen from its 1993 peak of 67 per cent of GDP to about 52 per cent. The top marginal tax rate is down to about 60 per cent (it varies depending on where you live), the same as Britain in the 1980s.

In a more or less closed economy, countries are free to choose the size of the state sector - if they want to pay higher tax and get better services they are free to vote for that. But in an increasingly open economy this choice closes off. It is already, in effect, closed for company taxation. It is starting to close for personal taxation too.

So whatever the provisions of the European constitution on tax powers, the reality will be set by the market. Of course it can try to buck that market. The result could then be rather on the lines suggested by the Paris think-tank, the Institut Français des Relations Internationales. In its recent report World Trade in the 21st Century, it warned that the EU, even after enlargement, might shrink by 2050 from its present 22 per cent of the world economy to a mere 12 per cent. "A slow but inexorable movement onto history's exit ramp is foreseeable." It painted other somewhat more optimistic scenarios - but it makes a sombre backdrop to grand ideas about the European constitution.

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