DIRECT TAX SYSTEM: INTRODUCTION
Taxation – Lecture 3
Content
• Tax system in EU - EU today and EU tax system from 1970 up today
• Tax system in CEE – from Soviet period up today
• Literature
Tax system in EU – general info
• EU - an economic and political partnership between, currently, 28
countries, which are generally referred to as the EU member
states. The first steps towards the European Union as it exists
today were taken at the end of the World War II. At first, the
founding six countries strived for an economic cooperation in
certain areas to avoid future conflict. To which effect, the countries
France, Germany, and Italy concluded the Treaty of Rome in
1957. The economic cooperation has since developed into an
internal market. Within the internal market, the European Union
strives to realize free movement of goods, services, persons and
capital. These are also referred to as the four freedoms. Also, the
European Union strives to achieve normal conditions for
competition, what is also called a level playing field. And
harmonization of national law, in so far as it hinders the functioning
of the internal markets. In 1993, the economic cooperation took on
a political and monetary dimension when the Maastricht Treaty
entered into force, and the European Union and Euro are
created.
Tax system in EU – general info
• EU institutions - EU operates through its institutions:
 the Council of the European Union (EU Council) - the
institution representing governments of the EU member
states. In the EU council, national ministers from each
country within the EU, meet to adopt laws and coordinate
policies. The EU council is divided into several different
configurations, based on policy areas. In regard of tax issue
important role is played by the Economic and Financial
Affairs Configuration (Ecofin), which is composed of the
Economic Finance Ministers of the EU member states.
 the European Commission (EC) - the executive body of the
European Union. The European Commission represents and
upholds the interests of the European Union as a whole.
It's responsible for proposing and drafting legislation and
manages the day-to-day business of implementing EU
policies and spending EU funds. The members of the EC
Tax system in EU – general info
are 28 in total, one from each member state. For purposes
of this course, the commissioners for taxation and competition
are particularly important. Currently, the posts are held by
Pierre Moscovici, a French national, and Margrethe
Vestager, a Danish national, respectively.
 the Court of Justice of the European Union - the highest
court in the EU, in matters of EU law.
• EU tax system
 EU tax policies and directives today – modern EU tax policy
in the European Union falls into two categories:
 the area of indirect taxation, which has been
harmonized to a large extent.
 the area of direct taxation, which remains almost the
sole responsibility of the member states. In this respect,
the EU strives to implement the consolidated corporate
tax base to address the underlying tax obstacles which
Tax system in EU – general info
exist for companies operating in more than one
member state. Yet, the creation of directives and
regulations in the area of direct taxation is, in principle,
subject to a unanimous approval of all member states.
As a result of lack of consensus, harmonization
through statute instruments, so-called, positive
harmonization, in the area of direct taxation has been
limited. Some steps for positive harmonization within the
EU have been taken though. The major DT tax-related
directives:
 the parent-subsidiary directive, which seeks to
abolish withholding facts of outgoing payments, and to
prevent economic double taxation within an EU based
corporate group structure.
 the merger directive seeks to facilitate tax neutral
corporate mergers, divisions, transfers of shares and
Tax system in EU – general info
exchanges of shares between EU based companies.
 the interest and royalty directive seeks to abolish
withholding tax on intra-group interest and royalty
payments.
In light of the limited positive harmonization measures, the
EU Court of Justice has over the past decades taken a
leading role of developing the internal market from a direct
tax perspective based on so-called, negative integration
by prohibiting member states, tax provisions, which
are contrary to internal market principles of the EU.
Tax system in EU – developments
• EU vs world – the European experiences may be briefly summarized
as follows: looking at the structure and evolution of the European
tax systems over the past 30 years, the EU area confirms its
peculiarities compared with the main international experiences
outside Europe (US and Japan) and, more generally, compared
with the OECD area. Major differences:
 in the EU area, the tax burden is, on average, higher than
in the OECD area - The ratio of taxes to GDP is a useful
scaling factor and a signal of the country’s preference for the
size of the public sector. According to OECD in the past 40
years tax ratios generally increased in OECD countries (by
9.1 percentage points) and EU countries (by 11.2
percentage points).
 European countries rely more on social security
contributions and less on consumption taxes; taxes on
labor and their contribution to total tax revenues
Tax system in EU – developments
are higher in Europe than in the OECD area. However, the
European averages show marked differences across
individual countries.
• Inside EU – a comprehensive picture of what has happened and
is happening in European fiscal systems is not at all easy to find.
The tax systems of the European countries (given by tax ratios,
tax structured by legal and economic categories and the allocation of
revenues across levels of government) are still widely different
from one another and, in general, there seems to have been
relatively little movement toward tax harmonization except in a
few areas. Furthermore, there is no obvious, ideal, or theoretical
system that is acting as a reference point for tax reforms. In
some way the situation has changed for the worse in recent decades.
While three or four decades ago there was some convergence of
views among tax experts on how a good tax system should look,
there in now no system that gets the approval of the majority of
Tax system in EU – developments
tax specialists. This explains why tax systems continue to be so
widely different among countries.
 Convergence – up to the mid-1980s, country divergences
increased considerably, while over the last 30 years the
separation between individual countries has largely been
reversed, most likely as a consequence of some common
pressures.
 1970s - in the early part of the 1970s European countries
were almost all mid-to-high fiscal pressure countries.
The total figure (taxes and social contributions) was
about 33 percent of GDP, and was already over that of
both the US (about 27 percent) and Japan (still at about
22 percent):
 Nordic countries: the fiscal pressure was very high.
It was made up in large amount by direct and (at a
smaller size) indirect taxes, to pay for a
comprehensive and advanced welfare state.
Tax system in EU – developments
 Rhine countries: the fiscal pressure was somewhat
higher than the European average. Direct taxes
prevailed in some countries, indirect ones’
elsewhere. Throughout the area, however, social
contributions raised to a high level, in order to finance a
generous Bismarckian welfare state.
 Anglo-Saxon countries: the fiscal pressure was still
close to the European average. Taxes’ share was far
larger than the share of social contributions. The
public health service was paid out from general tax
revenues. The public Beveridgean pension schemes
were tightened to only dispense low-amount social
security treatments.
 Mediterranean countries: the development’s delay
kept total fiscal pressure at a low level. Tax systems
had social contributions close to the European
average.
Tax system in EU – developments
Taxes (especially direct ones) still stood well below
European standards.
The shift to the “dual income tax system” did not
significantly change the fiscal structure of Nordic
countries. In the Rhine area, fiscal pressure grew yet
more. Personal income tax jumped up and social
contributions effected a further upward turn. The AngloSaxon
countries were left at the starting post: fiscal
pressure did not increase, nor was its structure
dramatically changed. Mediterranean countries marked
the main change: The total fiscal pressure of the
European development newcomers increased by about
10–15 points. Tax structure changed markedly in favor
of direct (in Spain, also indirect) taxes.
 1980s - no radical tax reforms occurred in 1980s, but
some common issues have arisen in the discussion of
tax design in European experiences:
Tax system in EU – developments
 Equity - conducted reforms have addressed the issue
of equity, which has been rather neglected during the
1970s’ season of reforms. In this respect, new tax
measures tried to introduce limited horizontal equity
objectives and reinforce progressivity. However, they
have mainly concerned tax rate cuts not only for the
bottom income levels, but also for the top levels.
 Competitiveness - is one of the main objectives of
many planned reforms, which aim at introducing tax
measures specifically targeted to increase national
competitiveness with respect to financial capital,
real capital and other production factors (mainly
labor).
 Innovation - tax bases have been broadened in
order to introduce tax incentives to selectively
stimulate innovation and growth in four areas (SMEs,
R&D investments, venture capital and stock options).
Tax system in EU – developments
 1990s and 2000s 
From 1990 to 2000, the implicit rate increased by
about two further points, equally distributed
between social contributions and income tax. As to
social contributions, just small cuts were introduced, by
no more than a few points, generally only at the lower
end of the wage scale and not in all European countries.
 Tax cuts of the income tax were similar, but usually
they were extended also to the top rate, sometimes in
quite a reasonable way, in other cases they were
planned for a provocatively heavy amount.
 The enlargement of the no-tax area was certainly
welcome, mostly as much as producing higher equity,
incentives on the labor supply being instead so minute
as to be, in fact, uncertain. Unfortunately the price paid
to implement this cut was a large increase of marginal
Tax system in EU – developments
rates over the no-tax area. To (partially) correct this
effect, new decreasing deductions had to be introduced,
complicating further a tax structure that any committed
country would seek to simplify. Furthermore the no-tax
area should have been enlarged up to a threshold able
to cover the equivalent household level of poverty; this
has rarely been achieved, especially for the households
with many dependents, i.e. by adopting a poor
equivalence scale.
 2010s - need for further changes - Three current key
factors which heavily impinge on European tax systems
and any future changes hoped for:
 Several years of tax competition and harmonization
efforts have, up to now, failed to set out a basic
common framework for a “European” tax system,
Tax system in EU – developments
 i.e. a system suitable for the present mixed
“Confederation”- to-“Federation” EU institutional
setting, and really enabling a mobility of people,
goods and capitals, within the single market and
free from fiscal distortions.
 The European economy’s growth rate decrease
seems at this point almost endless. Prospects for
future recovery are continuously postponed. Could
fiscal reforms really contribute to enhancing
economic growth? Furthermore, how should the tax
system be shaped in order to keep up the level of
welfare of the Pigouvian “national dividend,” by
matching the decreasing growth rate with increased
levels of fairness?
 The rebuilding of the European institutional setting
is just beginning. Common historical heritage of the
Tax system in EU – developments
federal states leads to a prediction of profound changes
in the allocation of government tiers’ taxing and
spending powers. Constitutional guarantees for the
satisfaction of basic needs are likely to be
strengthened.
A reduction of fiscal pressure is crucial for boosting
the declining growth and employment. To sustain this
proposal, a recurring argument is the comparison with
the USA, whose growth is higher but taxes much
lower. Fiscal competition in an increasingly integrated
world affected tax rates and structures of the most mobile
bases. Common opinion calls for more efficiency, thus
stressing the need for making taxes more simple and
neutral. Political factors, however, such as the pressure of
lobby groups, prevented this process from going very far.
Tax system in EU – developments
• Today in Europe the current tax mix, on average, is composed of:
 taxes on goods and services (30 percent),
 social security contributions (28.4 percent),
 personal income tax (25.6 percent),
 corporate income tax (9.2 percent)
 property taxes (5 percent).
In the last two decades a shift has occurred from the personal
income tax and social security contributions to the corporate
income tax and the property tax.
A closer look at the incidence of individual tax revenues by
economic categories (labor, capital and consumption) gives a
more useful explanation about the structure of the European tax
systems and their evolution: on average, taxes on labor
contribute for more than half the total tax revenue, consumption
Tax system in EU – developments
taxes for about one-third and taxes on capital for just about 15
percentage points. This tax mix has remained quite stable during
the 1990s and 2000s.
• PIT (DT) 
EU vs world - the average effective tax rate on labor in the
EU area appears to be higher than in the OECD area, even
if during the 1990s and 2000s many EU countries
introduced measures to lower the tax burden, mainly
financed through the shifting of the tax burden from labor
to capital or to broader tax and to activities that cause
pollution.
Looking at the total tax wedge on labor in the selected EU
countries during last 15 years, the tax burden:
 has decreased in France, Italy and the UK and more
markedly in Ireland and the Netherlands,
 remained constant in Germany and Spain.
Tax system in EU – developments
If, in general, labor is taxed more heavily in Europe than in
the OECD area, the issue appears to be most relevant for
lower-paid labor: concerns about high tax burdens on
lower-paid labor and possible substitution of (low-skill)
labor with other production factors or relocation abroad of
productive activities prompted initiatives in several EU
countries (France, the Netherlands, Spain and the UK) to
reduce effective tax wedges on low-paid workers.
 Inside EU – all EU countries turn from the model of the pure
comprehensive personal income tax in favor of some
hybrid taxation models where elements of expenditure tax
are present.
 Large differences exist in the treatment of the tax base
(taxable incomes and tax expenditures). Diversities are
mainly due to the different use of the tax systems to pay
social benefit, for instance tax breaks for private pensions.
Moreover not all income from capital is included in the
Tax system in EU – developments
personal income tax base.
 As a general trend, a growing number of countries
introduced lower, flat rates for certain types of capital
income (interest, dividends and capital gains).
 Family status is taken into account in the selected
countries in three major ways:
 through the application of a tax schedule that varies
according to family status. In this respect the tax unit
is the individual in Italy, the Netherlands and the UK,
while it is the family in France, Germany, Ireland and
(by option) in Spain;
 by providing tax credits and allowances related to
marital status and the presence of dependent
children. For instance, a tax credit is provided for
children in Germany, Italy, the Netherlands and the UK;
 by supplying cash transfers or benefit outside the tax
Tax system in EU – developments
System (e.g. cash transfers for dependent children).
 Looking at the structure of personal income tax,
countries differ in the way they give relief to low-income
individuals:
 A certain amount of income may be exempted from
tax (France, Spain and the UK) or taxed at 0 percent
(France and Germany).
 In other countries, basic tax relief is granted through tax
credits (Ireland and the Netherlands).
 Apart from Germany, which applies several tax formulae, in
the other countries, income is sliced into brackets,
ranging from two (Ireland) to seven (France). Income in
the first bracket is taxed at a low rate in the Netherlands
(2.95 percent), while Ireland and Italy apply higher tax rates
Tax system in EU – developments
(20 percent and 18 percent). Top marginal tax rates
range from 39.6 percent (Spain) to 52.75 percent
(France).
• CIT (DT) –
 Inside EU – although majority of EU countries have adopted a
flat corporate income tax, within the European Union,
corporate income taxes have not been harmonized (note:
generally these measures – adoption of flat CIT – are targeted
to stimulate entrepreneurship and to correct financial market
failures that can create obstacles to SMEs in raising new
capital)
It has been recognized, though early on, that corporate
income tax could easily distort the functioning of the EU's
internal market by affecting, for example, investment or
employment decisions:
 a person who engages in cross-border economic activity
may be subject to international juridical double tax-n
Tax system in EU – developments
(removed to a large extent by the EU court of justice - law
on EU free movement)
 a person who engages in cross-border economic activity
may be discriminated in the state in which he chooses
to do business. Because that state may have taken
protectionist tax measures. (removed to a large extent by
the EU court of justice - law on EU free movement)
 a person who engages in cross-border economic activity
and becomes subject to the tax rules of another tax
jurisdiction, may suffer an advantage or a disadvantage.
In comparison with the tax rules of his state of departure.
These disparities in the tax systems of EU member states are
a direct result of the fact that they have retained their fiscal
sovereignty. The fact that these disparities exist makes it
possible for EU member states to engage in so-called tax
competition. Many of them are looking at ways to attract and
Tax system in EU – developments
retain investment into their jurisdictions. In this respect, the
member states have become competitors – they compete
with each other by offering the lowest effective corporate
income tax. Often, such schemes have been used by
companies for tax planning purposes. From an internal
market perspective, tax competition can be counterproductive
and even harmful. Absent any real power to address harmful
tax competition at the EU level. Due to the unanimity
requirement in the area of direct taxation.
 Initiatives to reduce tax competition - several initiatives have
been developer to address harmful tax competition by other
means.
 On December 1st, 1997, the member states adopted the
Code of Conduct for business taxation to address
harmful tax competition. The Code of Conduct is not a
legally binding instrument, but has political force. In
the Code of Conduct, member states agreed to roll back
Tax system in EU – developments
existing measures that constitute harmful tax competition.
And to refrain from introducing new measures which
constitute harmful tax competition in the future.
 In 1998 to assess the tax measures the Code of Conduct
Group was established. In 1999, the group identified 66
tax measures with harmful features.
 Communication on Preventing and Combating
Financial and Corporate Malpractice - provides a
strategy for coordinated action to reduce the risk of
financial malpractice. The European Commission
suggests more transparency. And information exchange in
the field of corporate taxation.
Tax system in CEE – general info
• CEE - a group of countries that underwent a transformation, or a
transition, from being centrally planned to becoming market
economies. While transforming CEE tax systems from centrally
planed pattern to free market one, in some ways, their tax systems
have been adapting themselves to moving targets. It is to be
expected that this process will continue for a few more years until
the economies of these countries become fully market oriented,
with characteristics, structures, and institutions similar to those of the
other European countries. That this is not yet the case can be
seen, in part, from the levels of their per capita incomes that are
still much lower than those of the group of countries that they
joined.
Tax system in CEE – USSR
• At the beginning of 1990s much of the wealth of these New EU
countries was owned by the state. The citizens were not
expected to save and accumulate assets because the state, often
through the public enterprises in which most citizens worked, would
take care of them in old age or in illness. They did not need to save
as a precaution for being unemployed, because there was no
official unemployment. The state enterprises were required to absorb
any citizen who wanted a job. A large part of the income received by
the workers was in kind. The part received in cash was only a small
fraction of the income produced by a worker and there were a lot of
constraints, imposed by scarcity, on how this cash could be used.
Thus, to a great extent, the state determined both the level and
the pattern of the consumption by individuals. Individual
decisions had little influence on the allocation of resources. This
was done through state planning.
• In some ways classical central planning was an effective and
esthetically attractive social instrument that fascinated many western
Tax system in CEE – USSR
social scientists. Unfortunately, by limiting individual liberties and
by killing individual incentives, it carried an enormous cost in
terms of economic efficiency and political liberty. As time passed,
the centrally planned economies became increasingly inefficient
and unable to satisfy the consumption needs of their
populations.
• In that central-planning environment, the role of the tax system
was limited and there was hardly any need for a western-style
tax administration. Taxes on labor income were collected directly
from the state enterprises, by simply adjusting the cash
transfers that they received from the central bank to pay the
wage bill. There was no objective definition of enterprise income
to determine precisely the taxes on profits. The payment from an
enterprise to the state was negotiated; it was not based on the actual
profits. The depreciation allowances for the use of capital assets bore
little or no relation to the useful life of the real assets used. There
were no laws that defined the turnover taxes. These were
Tax system in CEE – USSR
determined arbitrarily in the plan and reflected both social
considerations that favored particular items (children’s clothes, art
books, etc), as well as supply and demand conditions. When there
was excessive inventory of an item, the turnover tax was
reduced to induce citizens to buy more of this item. Therefore,
the turnover taxes could be in the thousands and changed
frequently.
• “The life of a tax administrator was easy (during central planning). He
often had to deal with just one enterprise. Much revenue came from
an occasional telephone call. Now you have to work for every cent”
(Tanzi 1993, p. 7). Thus, one thing that these countries had to
learn was how to collect taxes from taxpayers that would rather
evade paying them.
Tax system in CEE – Transformation
• The reforms introduced by the New EU countries had to cope with
economies in which prices and wages are free to fluctuate, private
sector activities become important, there are no controls on the output
of enter prises, so that their incomes are not known and payments
can be made in various forms and no longer through just one
‘monobank’. This new situation would demand both new tax
systems and new tax administrations. Furthermore, these had to
be adjusted over the years to conform with the changes in the
structure of the economy. It would not be imprudent to say that the tax
systems of these countries have come a long way and that from now
on they will need more fine tuning than radical surgery.
Tax system in CEE – today
• Particularities of modern CEE tax systems:
 The closeness of their current tax burdens - in fact these
tax burdens are all close to 40 percent of GDP, having come
down from higher levels. A tax burden of 40 percent of GDP
may be close to, or even lower than, the European average but
it is very high considering these countries’ still low per
capita incomes. From an international statistical perspective,
the tax burden of these countries could be expected to be
somewhat lower. Thus, a question that needs to be raised is
whether the current tax levels are sustainable over time. It
would be reasonable to speculate that they are likely to fall as
the transformation of these economies continues. This fall
would require a reduction in public spending.
 In spite of their high tax levels, all of these countries, with the
exception of Estonia, have developed high budgetary
deficits, which have been growing in recent years. This
implies that these countries have not succeeded yet in
Tax system in CEE – today
reducing the role of the state to a level that can be financed
through ordinary tax revenue. The state is still expected to
do too much despite various reforms aimed at reducing its
role and responsibilities. This aspect could become a
problem that would extend beyond the need to meet the
Maastricht criteria. The fiscal gap must be closed by
reducing public spending rather than by increasing the
high level of taxation.
 The extent to which labor income is taxed. This is partly due
to the large payments for social security contributions,
which in some of these countries, such as the Czech
Republic, are among the highest in the world. This heavy
burden on labor income must be reduced if the development of
growing underground activities is to be prevented. This growth
of underground economic activities is already under way in
several of these countries and is likely to accelerate with the
passing of time.
Tax system in CEE – today
 The almost uniform move towards fiscal decentralization.
Undoubtedly this is a political reaction against the
powerful central governments of the past. Once the
communist regimes were replaced, the citizens of these
countries were anxious to have more ‘voice’ and more control
over decisions that affected their lives. However, regardless of
its political merit, this process of decentralization is likely
to constrain future tax reform and to affect negatively
future macroeconomic developments. Experience from
around the world indicates that it is often more difficult to
reduce fiscal deficits in a fiscally decentralized
environment.
 The growing use of environmental taxes in these
countries. The centrally planned past had left these countries
with major environmental problems that affected health and life
expectancies. Many in these countries have low life
expectancy, perhaps due to the quality of the environment.
Tax system in CEE – today
Thus, the attempt to reduce this problem through the use of tax
instruments is one that deserves praise.
 After labor income, consumption is the other tax base that
carries much of the tax burden. All these countries have
introduced value added taxes, which with some adjustments
will conform with the requirements of the European Union.
However, there are still too many excises and other small
taxes. Some of these will have to disappear in future years.
Property taxes are still playing a marginal role. This is not
surprising since, until twenty five years ago, there was no
or little private property. However, in future years, it would
be preferable to give a growing importance to this tax
base, especially for financing the local governments, while
reducing the reliance on revenue sharing arrangements that
transfer to the local governments parts of the revenue from
personal income taxes and corporate income taxes.
Literature
• MCGEE, Robert W. The philosophy of taxation and public finance.
Boston: Kluwer Academic Publishers, 2004. viii, 313.
ISBN 1402077165.
• RADVAN, Michal. Czech Tax Law - 3rd ed. 3. vyd. Brno: Masarykova
univerzita, 2010. 65 s. Fac. of Law Publ. no. 4 (Edition of textbooks).
ISBN 978-80-210-5269-7
• BERNARDI, Luigi. Tax Systems and Tax Reforms in Europe, 2003.
Routledge. ISBN 0415322510.
• BERNARDI, Luigi. Tax Systems and Tax Reforms in New EU Member
States, 2004. Routledge. ISBN 0415349885.
• Coursera: Rethinking International Tax Law. Universiteit Leiden
https://www.coursera.org/learn/international-taxation/