Developed Countries Finance

Key terms: budget policy, tax structure, income tax, consumption taxes, double
taxation, imputation system, custom-enforcement area, currency areas

Questions for discussion:

1. How do internationalization and globalization affect public finance of countries

with developed market economies?

2.National specific of tax system?

3. The modern problems of social security (welfare).

4. What is the main idea of the coordination of fiscal regulation?

5. Specific of the budget process in countries with developed market economies.

What is 'Globalization'?
Globalization represents the global integration of international trade, investment,
information technology and cultures. Government policies designed to open economies
domestically and internationally to boost development in poorer countries and raise
standards of living for their people are what drive globalization. However, these policies
have created an international free market that has mainly benefited multinational
corporations in the Western world to the detriment of smaller businesses, cultures and
common people. 

Through globalization, corporations can gain a competitive advantage from lower

operating costs, and access to new raw materials and additional markets. In
addition, multinational corporations can manufacture, buy and sell goods worldwide. For
example, a Japan-based car manufacturer can manufacture auto parts in
several developing countries, ship the parts to another country for assembly and sell the
finished cars to any nation.

Globalization is not a new concept. In ancient times, traders traveled vast distances to

buy rare commodities such as salt, spices and gold, which they would then sell in their
home countries. The 19th century Industrial Revolution brought advances in
communication and transportation that have removed borders and increased cross-border
trade. In the last few decades, globalization has occurred at an unprecedented pace.
Public policy and technology are the two main driving factors behind the current
globalization boom. Over the past 20 years, governments worldwide have integrated
a free market economic system through fiscal policies and trade agreements. This
evolution of economic systems has increased industrialization and financial
opportunities abroad. Governments now focus on removing barriers to trade and
promoting international commerce.

Technology is a major contributor to globalization. Advancements in IT and the flow of

information across borders have increased awareness among populations of economic
trends and investment opportunities. Technological advancement such as digitalization
has simplified and accelerated the transfer of financial assets between countries. 

The Broader Meaning of Globalization

Globalization is also a social, cultural, political and legal phenomenon. In social terms,
globalization represents greater interconnectedness among global populations.
Culturally, globalization represents the exchange of ideas and values among cultures,
and even a trend toward the development of a single world culture. Politically,
globalization has shifted countries' political activities to the global level through
intergovernmental organizations like the United Nations and the World Trade
Organization. With regard to law, globalization has altered how international law is
created and enforced.

The Globalization Controversy

Proponents of globalization believe it allows developing countries to catch up to
industrialized nations through increased manufacturing, diversification, economic
expansion and improvements in standards of living. China is a good example of a
national economy that has benefited immensely from globalization.

Outsourcing by companies brings jobs and technology to developing countries. Trade

initiatives increase cross-border trading by removing supply-side and trade-related
constraints. The North American Free Trade Agreement, for example, encouraged U.S.
car manufacturers to relocate operations to Mexico where labor costs are lower, and
many U.S. companies have outsourced call centers to India.

Globalization has advanced social justice on an international scale, and globalization

advocates report that it has drawn attention to human rights worldwide. In addition,
some feel the spread of pop culture across borders will advance the exchange of ideas,
art, language and music.

Disadvantages of Globalization
Economic downturns in one country can affect other countries' economies through a
domino effect. For example, when Greece experienced a debt crisis in 2010, the all of
Europe felt the impact. In addition, globalization may have disproportionately benefited
Western corporations and enhanced wealth disparity.
Free trade implies a greater risk of failure for small, private or family-owned companies
competing in a global market. There is also a digital divide because not all populations
have internet access. Some suggest that globalization has created a concentration of
information and power in the hands of a small elite, and certain groups have acquired
resources and power that exceed those of any single nation, posing new threats to human
rights on an international scale.

Standards of living have risen overall as more third-world countries experience

industrialization. However, some politicians argue that globalization is detrimental to
the middle class, and is causing increasing economic and political polarization in the
United States. Outsourcing, where U.S. companies transfer their facilities abroad to
lower labor costs and avoid negotiating with unions, means workers in the United States
must now compete internationally for jobs.

Globalization has contributed to global warming, climate change and the overuse of

natural resources. An increase in the demand for goods has boosted manufacturing and
industrialization. Globalization has also increased homogenization in countries. For
example, international chains, such as Starbucks, Nike and The Gap, dominate
commercial space in every U.S. town and many towns in other nations. Cultural
exchange has been largely one-sided because U.S. goods and culture have influenced
other countries more than those of any other nation. 

Pros

Supporters of globalization argue that it has the potential to make this world a
better place to live in and solve some of the deep-seated problems like
unemployment and poverty.

1. Free trade is supposed to reduce barriers such as tariffs, value added taxes,
subsidies, and other barriers between nations. This is not true. There are still
many barriers to free trade. The Washington Post story says “the problem is
that the big G20 countries added more than 1,200 restrictive export and
import measures since 2008

2. The proponents say globalization represents free trade which promotes

global economic growth; creates jobs, makes companies more competitive,
and lowers prices for consumers.

3. Competition between countries is supposed to drive prices down. In many

cases this is not working because countries manipulate their currency to get a
price advantage.

4. It also provides poor countries, through infusions of foreign capital and

technology, with the chance to develop economically and by spreading
prosperity, creates the conditions in which democracy and respect for human
rights may flourish. This is an ethereal goal which hasn’t been achieved in
most countries
5. According to supporters globalization and democracy should go hand in
hand. It should be pure business with no colonialist designs.

6. There is now a worldwide market for companies and consumers who have
access to products of different countries. True

7. Gradually there is a world power that is being created instead of

compartmentalized power sectors. Politics is merging and decisions that are
being taken are actually beneficial for people all over the world. This is simply
a romanticized view of what is actually happening. True

8. There is more influx of information between two countries, which do not

have anything in common between them. True

9. There is cultural intermingling and each country is learning more about

other cultures. True

10. Since we share financial interests, corporations and governments are

trying to sort out ecological problems for each other. – True, they are talking
more than trying.

11. Socially we have become more open and tolerant towards each other and
people who live in the other part of the world are not considered aliens. True
in many cases.

12. Most people see speedy travel, mass communications and quick
dissemination of information through the Internet as benefits of
globalization. True

13. Labor can move from country to country to market their skills. True, but
this can cause problems with the existing labor and downward pressure on
wages.

14. Sharing technology with developing nations will help them progress. True
for small countries but stealing our technologies and IP have become a big
problem with our larger competitors like China.

15. Transnational companies investing in installing plants in other countries

provide employment for the people in those countries often getting them out
of poverty. True

16. Globalization has given countries the ability to agree to free trade
agreements like NAFTA, South Korea Korus, and The TPP. True but these
agreements have cost the U.S. many jobs and always increase our trade deficit

Cons
• The general complaint about globalization is that it has made the rich richer
while making the non-rich poorer. “It is wonderful for managers, owners and
investors, but hell on workers and nature.”

• Globalization is supposed to be about free trade where all barriers are

eliminated but there are still many barriers. For instance161 countries have
value added taxes (VATs) on imports which are as high as 21.6% in Europe.
The U.S. does not have VAT.

• The biggest problem for developed countries is that jobs are lost and
transferred to lower cost countries.” According to conservative estimates by
Robert Scott of the Economic Policy Institute, granting China most favored
nation status drained away 3.2 million jobs, including 2.4 million
manufacturing jobs. He pegs the net losses due to our trade deficit with Japan
($78.3 billion in 2013) at 896,000 jobs, as well as an additional 682,900 jobs
from the Mexico –U.S. trade-deficit run-up from 1994 through 2010.”

• Workers in developed countries like the US face pay-cut demands from

employers who threaten to export jobs. This has created a culture of fear for
many middle class workers who have little leverage in this global game

• Large multi-national corporations have the ability to exploit tax havens in

other countries to avoid paying taxes.

• Multinational corporations are accused of social injustice, unfair working

conditions (including slave labor wages, living and working conditions), as
well as lack of concern for environment, mismanagement of natural
resources, and ecological damage.

• Multinational corporations, which were previously restricted to commercial

activities, are increasingly influencing political decisions. Many think there is
a threat of corporations ruling the world because they are gaining power, due
to globalization.

• Building products overseas in countries like China puts our technologies at

risk of being copied or stolen, which is in fact happening rapidly

• The anti-globalists also claim that globalization is not working for the
majority of the world. “During the most recent period of rapid growth in
global trade and investment, 1960 to 1998, inequality worsened both
internationally and within countries. The UN Development Program reports
that the richest 20 percent of the world's population consume 86 percent of
the world's resources while the poorest 80 percent consume just 14 percent. “

• Some experts think that globalization is also leading to the incursion of

communicable diseases. Deadly diseases like HIV/AIDS are being spread by
travelers to the remotest corners of the globe.
• Globalization has led to exploitation of labor. Prisoners and child workers
are used to work in inhumane conditions. Safety standards are ignored to
produce cheap goods. There is also an increase in human trafficking.

• Social welfare schemes or “safety nets” are under great pressure in

developed countries because of deficits, job losses, and other economic
ramifications of globalization.

Globalization is an economic tsunami that is sweeping the planet. We can’t

stop it but there are many things we can do to slow it down and make it more
equitable.

The Globalization of Finance

Gerd Häusler

During the past two decades, financial markets around the world have become
increasingly interconnected. Financial globalization has brought considerable benefits
to national economies and to investors and savers, but it has also changed the structure
of markets, creating new risks and challenges for market participants and policymakers.

Three decades ago, a manufacturer building a new factory would probably have been
restricted to borrowing from a domestic bank. Today it has many more options to choose
from. It can shop around the world for a loan with a lower interest rate and borrow in
foreign currency if foreign-currency loans offer more attractive terms than domestic-
currency loans; it can issue stocks or bonds in either domestic or international capital
markets; and it can choose from a variety of financial products designed to help it hedge
against possible risks. It can even sell equity to a foreign company.

A look at how financial globalization has occurred, and the form it is taking, offers
insights into its benefits as well as the new risks and challenges it has generated.

Forces driving globalization

What has driven the globalization of finance? Four main factors stand out.

Advances in information and computer technologies have made it easier for market

participants and country authorities to collect and process the information they need to
measure, monitor, and manage financial risk; to price and trade the complex new
financial instruments that have been developed in recent years; and to manage large
books of transactions spread across international financial centers in Asia, Europe, and
the Western Hemisphere.

The globalization of national economies has advanced significantly as real economic

activity—production, consumption, and physical investment—has been dispersed over
different countries or regions. Today, the components of a television set may be
manufactured in one country and assembled in another, and the final product sold to
consumers around the world. New multinational companies have been created, each
producing and distributing its goods and services through networks that span the globe,
while established multinationals have expanded internationally by merging with or
acquiring foreign companies. Many countries have lowered barriers to international
trade, and cross-border flows in goods and services have increased significantly. World
exports of goods and services, which averaged $2.3 billion a year during 1983-92, have
more than tripled, to an estimated $7.6 billion in 2001. These changes have stimulated
demand for cross-border finance and, in tandem with financial liberalization, fostered the
creation of an internationally mobile pool of capital and liquidity.

The liberalization of national financial and capital markets, coupled with the rapid
improvements in information technology and the globalization of national economies,
has catalyzed financial innovation and spurred the growth of cross-border capital
movements. The globalization of financial intermediation is partly a response to the
demand for mechanisms to intermediate cross-border flows and partly a response to
declining barriers to trade in financial services and liberalized rules governing the entry
of foreign financial institutions into domestic capital markets. Global gross capital flows
in 2000 amounted to $7.5 trillion, a fourfold increase over 1990. The growth in cross-
border capital movements also resulted in larger net capital flows, rising from $500
billion in 1990 to nearly $1.2 trillion in 2000.

Competition among the providers of intermediary services has increased because of

technological advances and financial liberalization. The regulatory authorities in many
countries have altered rules governing financial intermediation to allow a broader range
of institutions to provide financial services, and new classes of nonbank financial
institutions, including institutional investors, have emerged. Investment banks, securities
firms, asset managers, mutual funds, insurance companies, specialty and trade finance
companies, hedge funds, and even telecommunications, software, and food companies
are starting to provide services similar to those traditionally provided by banks.

Changes in capital markets

These forces have, in turn, led to dramatic changes in the structure of national and
international capital markets.

First, banking systems in the major countries have gone through a process of
disintermediation—that is, a greater share of financial intermediation is now taking place
through tradable securities (rather than bank loans and deposits). Both financial and
nonfinancial entities, as well as savers and investors, have played key roles in, and
benefited from, this transformation. Banks have increasingly moved financial risks
(especially credit risks) off their balance sheets and into securities markets—for
example, by pooling and converting assets into tradable securities and entering into
interest rate swaps and other derivatives transactions—in response both to regulatory
incentives such as capital requirements and to internal incentives to improve risk-
adjusted returns on capital for shareholders and to be more competitive. Corporations
and governments have also come to rely more heavily on national and international
capital markets to finance their activities. Finally, a growing and more diverse group of
investors are willing to own an array of credit and other financial risks, thanks to
improvements in information technology that have made these risks easier to monitor,
analyze, and manage.
Second, cross-border financial activity has increased. Investors, including the
institutional investors that manage a growing share of global financial wealth, are trying
to enhance their risk-adjusted returns by diversifying their portfolios internationally and
are seeking out the best investment opportunities from a wider range of industries,
countries, and currencies. At the wholesale level, national financial markets have
become increasingly integrated into a single global financial system. The major financial
centers now serve borrowers and investors around the world, and sovereign borrowers at
various stages of economic and financial development can access capital in international
markets. Multinational companies can tap a range of national and international capital
markets to finance their activities and fund cross-border mergers and acquisitions, while
financial intermediaries can raise funds and manage risks more flexibly by accessing
markets and pools of capital in the major international financial centers.

Third, the nonbank financial institutions are competing—sometimes aggressively—with

banks for household savings and corporate finance mandates in national and
international markets, driving down the prices of financial instruments. They are
garnering a rising share of savings, as households bypass bank deposits to hold their
funds in higher-return instruments—such as mutual funds—issued by institutions that
are better able to diversify risks, reduce tax burdens, and take advantage of economies of
scale, and have grown dramatically in size as well as in sophistication.

Fourth, banks have expanded beyond their traditional deposit-taking and balance-sheet-
lending businesses, as countries have relaxed regulatory barriers to allow commercial
banks to enter investment banking, asset management, and even insurance, enabling
them to diversify their revenue sources and business risks. The deepening and
broadening of capital markets has created another new source of business for banks—the
underwriting of corporate bond and equity issues—as well as a new source of financing,
as banks increasingly turn to capital markets to raise funds for their own investment
activities and rely on over-the-counter (OTC) derivatives markets—decentralized
markets (as opposed to organized exchanges) where derivatives such as currency and
interest rate swaps are privately traded, usually between two parties—to manage risks
and facilitate intermediation.

Banks have been forced to find additional sources of revenue, including new ways of
intermediating funds and fee-based businesses, as growing competition from nonbank
financial intermediaries has reduced profit margins from banks' traditional business—
corporate lending financed by low-cost deposits—to extremely low levels. This is
especially true in continental Europe, where there has been relatively little consolidation
of financial institutions. Elsewhere, particularly in North America and the United
Kingdom, banks are merging with other banks as well as with securities and insurance
firms in efforts to exploit economies of scale and scope to remain competitive and
increase their market shares.

Benefits versus risks

All in all, the radical change in the nature of capital markets has offered unprecedented
benefits. But it has also changed market dynamics in ways that are not yet fully
understood.
One of the main benefits of the growing diversity of funding sources is that it reduces
the risk of a "credit crunch." When banks in their own country are under strain,
borrowers can now raise funds by issuing stocks or bonds in domestic securities markets
or by seeking other financing sources in international capital markets. Securitization
makes the pricing and allocation of capital more efficient because changes in financial
risks are reflected much more quickly in asset prices and flows than on bank balance
sheets. The downside is that markets have become more volatile, and this volatility could
pose a threat to financial stability. For example, the OTC derivatives markets, which
accounted for nearly $100 trillion in notional principal and $3 trillion in off-balance-
sheet credit exposures in June 2001, can be unpredictable and, at times, turbulent.
Accordingly, those in charge of preserving financial stability need to better understand
how the globalization of finance has changed the balance of risks in international capital
markets and ensure that private risk-management practices guard against these risks.

Another benefit of financial globalization is that, with more choices open to them,
borrowers and investors can obtain better terms on their financing. Corporations can
finance physical investments more cheaply, and investors can more easily diversify
internationally and tailor portfolio risk to their preferences. This encourages investment
and saving, which facilitate real economic activity and growth and improve economic
welfare. However, asset prices may overshoot fundamentals during booms and busts,
causing excessive volatility and distorting the allocation of capital. For example, real
estate prices in Asia soared and then dropped precipitously before the crises of 1997-98,
leaving many banks with nonperforming loans backed by collateral that had lost much of
its value. Also, as financial risk becomes actively traded among institutions, investors,
and countries, it becomes harder to identify potential weaknesses and to gauge the
magnitude of risk. Enhanced transparency about economic and financial market
fundamentals, along with a better understanding of why asset market booms and busts
occur, can help markets better manage these risks.

Finally, creditworthy banks and firms in emerging market countries can reduce their
borrowing costs now that they are able to tap a broader pool of capital from a more
diverse and competitive array of providers. However, as we saw during the Mexican
crisis of 1994-95 and the Asian and Russian crises of 1997-98, the risks involved can be
considerable—including sharp reversals of capital flows, international spillovers, and
contagion. (Even though the extent of contagion seems to have decreased, for reasons
that are still unclear, since the 1997-98 crises, the risk of contagion cannot be ruled out.)
Emerging market countries with weak or poorly regulated banks are particularly
vulnerable, but such crises can threaten the stability of the international financial system
as well.

Safeguarding financial stability

The crises of the 1990s underscored the need for prudent sovereign debt management,
properly sequenced capital account liberalization, and well-regulated and resilient
domestic financial systems, to ensure national and international financial stability.

Private financial institutions and market participants can contribute to financial stability
by managing their businesses and financial risks well and avoiding imprudent risk taking
—in part by responding to market incentives and governance mechanisms, such as
maximizing shareholder value and maintaining appropriate counterparty relationships in
markets. In effect, the first lines of defense against financial problems and systemic risks
are sound financial institutions, efficient financial markets, and effective market
discipline.

But, because financial stability is also a global public good, national supervisors and
regulators must also play a role. Indeed, this role is becoming increasingly international
in scope—for example, through a strengthening of coordination and information sharing
across countries and functional areas (banking, insurance, securities) to identify financial
problems before they become systemic.

The IMF itself has an important role to play. In accordance with its global surveillance
mandate, it has launched a number of initiatives to enhance its ability to contribute to
international financial stability: identifying and monitoring weaknesses and
vulnerabilities in international financial markets; developing early warning systems for
international financial market imbalances; conducting research into the nature and
origins of international financial crises and the channels of contagion; and seeking ways
to contain and resolve crises quickly and smoothly, for example, by involving the private
sector.

Financial globalization and financial integration are, in principle, different

concepts. Financial globalization is an aggregate concept that refers to increasing global
linkages created through cross-
border financial flows. Financial integration refers to an individual country's linkages to
international capital markets. Clearly, these concepts are closely related. For instance,
increasing financial globalization is perforce associated with increasing financial
integration on average

Taxation systems[edit]

Systems of taxation on personal income

  No income tax on individuals
   Territorial
  Residence-based
  Citizenship-based
Countries that tax income generally use one of two systems: territorial or residence-based. In the
territorial system, only local income – income from a source inside the country – is taxed. In the
residence-based system, residents of the country are taxed on their worldwide (local and foreign)
income, while nonresidents are taxed only on their local income. In addition, a very small number of
countries, notably the United States, also tax their nonresident citizens on worldwide income.
Countries with a residence-based system of taxation usually allow deductions or credits for the tax that
residents already pay to other countries on their foreign income. Many countries also sign tax
treaties with each other to eliminate or reduce double taxation. In the case of corporate income tax,
some countries allow an exclusion or deferment of specific items of foreign income from the base of
taxation.
ax harmonization is generally understood as a process of adjusting tax systems of different
jurisdictions in the pursuit of a common policy objective. Tax harmonization involves the removal of tax
distortions affecting commodity and factor movements in order to bring about a more efficient allocation
of resources within an integrated market. Tax harmonization may serve alternative goals, such as equity
or stabilization. It also can be subsumed, along with public expenditure harmonization, under the
broader concept of fiscal harmonization. Narrowly defined, tax harmonization guided by this policy goal
implies — under simplifying assumptions about other policy instruments and economic structure —
convergence toward a more uniform effective tax burden on commodities or on factors of production.
Convergence may be attained through the alignment of one or several elements that enter the
determination of effective tax rates: the statutory tax rate and tax base, and enforcement practices.
Perhaps the most widely accepted argument for harmonization involves convergence in the definition of
product value or income for tax purposes. Such tax base harmonization would contribute to
transparency for economic decision-making and, thus, to improved efficiency in resource allocation. In
particular, a common income tax base for multinational companies operating in different jurisdictions
would be instrumental not only in enhancing efficiency, but also in preventing overlaps or gaps in tax
claims by different countries.[1] Tax harmonization is an important part of the fiscal integration process.
Fiscal integration is the process by which a group of countries agree on taking measures that lead to a
higher level of fiscal convergence, the ultimate goal being the formation of a fiscal union. Tax
harmonization doesn’t automatically lead to the formation of a fiscal union, the second part involving
much larger scale project that includes fiscal transfers, a fully harmonized legislation and maybe some
supervising institutions, beside a long-run agreement. Starting from the definition given to the fiscal
integration process, we can easily say that tax harmonization is the process by which a heterogeneous
group of countries, federal states or even local governments agree on setting a minimum and maximum
level of their tax rates, including also a higher degree of harmonization of tax legislation, in order to
attract foreign investors and to encourage local development and investments. [2]

Tax harmonization vs. tax competition[edit]

There is a trade-off between tax harmonization and tax competition. Controlling tax rates not only
stabilizes tax revenues, but is also sometimes necessary for moving forward with economic and political
integration. On the other hand, deregulating tax rates maintains the autonomy of member countries in
tax matters for their own short-term economic and social policy purposes. In addition, it mitigates
political distortions.[2]

Tax harmonization advantages[edit]

Does not lead to the race to the bottom
Since regions have harmonized tax rates, they do not compete over capital by reducing tax rates. This
prevents all regions to reduce their tax rates in order to ensure that their country is the most attractive
from the point of view of tax costs. However, this battle has its own price, the reduction of tax rates
bringing with it a reduction in tax revenues.
Less costs regarding public revenues tax rates are common set and do not disadvantage or advantage
just one region;
The harmonization of legislation will bring with it less costs for multinational companies;
Allows the use of fiscal transfers between regions, reducing borrowing costs on capital markets or from
private or international lenders.

Disadvantages of tax harmonization[edit]

Implies cooperation between different regions, fact that isn’t always possible giving the fact that
politicians and the general public are sceptic about fiscal integration;
A coordination and surveillance institution is necessary, thus presenting additional costs;
Needs to solve the problem of the democratic deficit;
Given the fact in some regions tax rates will increase, tax evasion may spread.

Tax harmonization in EU[edit]

In the EU the policy of tax harmonization is not regular in the taxation field however in order to have a
well-functioning single market the alteration of national fiscal policies is key. Through the actions of
European Institutions (fiscal policy coordination, harmonization of tax laws, etc.), or by the action of the
European Court of Justice (prohibiting certain national tax rules that violate EU rules) tax harmonization
can be achieved. [3]

VAT[edit]
The Value-Added Tax (VAT) is part of the acquis communautaire, and two directives (1977 and 2006)
closely codify the VAT regime in EU Member states, with a minimum standard rate of 15% and a
restricted list of reduced rates. Excise duties are also subject to minimum rates, based on Articles 191-
192 of the Treaty on the Functioning of the European Union (TFEU). This treaty base allows the Council
and the Parliament to take decisions, including on taxes, to protect human health, safeguard the
environment and promote a “rational utilization of natural resources”. [4]

Capital income tax[edit]

In 1990, the Parent-subsidiary directive tackled the issue of double taxation of repatriated profits by a
mother company from its subsidiaries.4 Member states are requested either to exempt repatriated
profits, or to deduct taxes already paid by the affiliates from the mother's tax bill (partial credit system).
The objective was to avoid discriminating against foreign subsidiaries (taxed twice) in relation to purely
domestic firms (taxed only once). In 2003, the Interest and Royalties directive further reduced the
incidence of double taxation by abolishing withholding taxes on cross-border interest and royalty
payments within the EU.[4]

Discussions

The question 1: What does it mean Tax Harmonization?

1.Tax harmonization consists in coordinating the taxation systems of the European countries to
avoid non-concerted and competing changes in national fiscal policies, which could have an
adverse effect on the internal market.

2.Total tax harmonization means the result of the structural harmonization and harmonization
of the tax rates.

3.The structural harmonization means the result of the harmonization of the structure of taxes
(especially the tax rules and tax bases).

Tax harmonization can also be understood as the process, the tools for reaching the selected aim and
the result, harmonization of tax legislation itself together.

Once the concepts defined and the asymmetric income tax rates presented, it becomes very clear that
full tax harmonization covering 28 countries is a difficult undertaking, since this area remains largely
the prerogative of the Member States.
The question 2: Do we need a tax harmonization in EU?

Yes, we need for at least four reasons:

1.to stop the harmful tax competition.

2.to reduce the tax evasion.

3.to reduce the cost of tax compliance of companies doing business within EU

4.to fully take advantage of the common market.

The question 3: If the reasons exist, why is it so difficult to harmonize the income taxes in EU?

I will try to systemize the answers as it fallows:

1.The fiscal policy is one of the few macroeconomic tools that governments have at their
disposal to influence the business cycle/economic growth (especially for the Eurozone member
states).

2.Taxation is a determinant for investments and particularly for FDI (foreign direct investment).
Logically, investors will be attracted by the countries with low tax rates. Emerging economies
have become more and more attractive to investors and FDI in these countries is increasing.

3.Making the reality more complex that it should be according to the previous answer, the
empirical evidence shows that most of FDI inflows are still oriented to the developed
economies, despite their higher level of taxation, which means that higher tax rates create better
business environment. A high CIT/PIT rate will stimulate the FDI inflows if the revenue is used to
provide public goods that improve the environment in which investors operate.

4.In the case of harmonization of the tax rate, which will be the common tax rate in EU? Will it be
the actual average? It means 22,8% CIT rate, and 39,3% PIT rate. Is it a proper solution?

5.From the perspective of Laffer theory (see graph no1), it exists a critical tax rate (t ∙*) which
rises to a maximum rate of revenue (Tmax), depending on the level of the economic
development of the country. A tax increase (t3 > t ∙*) or cut (t1 < t ∙*) may reduce taxed activity
and raise less revenue than otherwise predicted (T1 < Tmax), just as a tax cut (t3 < tmax) may
increase taxed activity and raise more revenue than otherwise predicted, depending on the
actual critical tax rate. Therefore, the critical tax rate differs from country to country. We can
conclude that there are 28 critical different tax rates (t ∙*) in EU.

What will happen in the case of harmonization by adopting the actual average tax rate?

The countries with lower tax rates will lose revenues by moving in the right part of the t ∙* (Bulgaria,
Cyprus, Czech Republic, Ireland, Latvia, Lithuania, Poland, Romania, Slovenia) and the countries with
higher tax rates will lose revenue by moving in the left side of the t ∙* (Belgium, France, Germany, Italy,
Portugal, Malta, Spain). Therefore, the above solution is not a proper one. (Of course, the shape of the
curve is a simplified one.).

Graph.no.1 The Laffer Curve

Conclusion

1.Tax harmonization is an almost impossible goal for European Union.

2.So many national different tax regulations pose problems for all companies doing business
abroad.
 3.The solution could be the harmonization of the tax basis (the structural harmonization).

Budget Preparation
A full understanding of the budget planning and preparation system is essential, not
just to derive expenditure projections but to be able to advise policymakers on the
feasibility and desirability of specific budget proposals, from a macroeconomic or
microeconomic perspective. It is much easier to control government expenditures at
the "upstream" point of budget preparation than later during the execution of the
budget.
Thus, fiscal economists and general budget advisors need to know:
what is the framework in which budget decisions are made;
who is responsible for planning and preparing the budget;
what are the basic steps;
what are the typical weaknesses in procedures and how can these be overcome;
and
how can changes in budget plans be programmed and targeted?
Answers to these questions are set out in the subsections below.
Budget planning and preparation are (or should be) at the heart of good public
expenditure management. To be fully effective, public expenditure management
systems require four forms of fiscal and financial discipline:
1.control of aggregate expenditure to ensure affordability; that is, consistency with
the macroeconomic constraints;
2.effective means for achieving a resource allocation that reflects expenditure
policy priorities;
3.efficient delivery of public services (productive efficiency); and
4.minimization of the financial costs of budgetary management (i.e., efficient
budget execution and cash and debt management practices).
Budget preparation is the principal mechanism for achieving items (1) and (2); item
(3) typically features as an element of budget preparation only in industrial countries,
while item (4) is essentially an issue in budget execution and cash management
(see Sections 4and 5). Moreover, no system of budget execution or cash planning (the
subjects of Sections 4 and 5) can do more than mitigate the problems caused by poor
quality or unrealistic budget preparation.
What is the framework in which budget decisions are made?
Budget preparation is a process with designated organizations and individuals having
defined responsibilities that must be carried out within a given timetable (see Figure
1 in Section 1 for a typical time line). This process is normally established and
controlled by a legal and regulatory framework. While generally sharing broadly
common procedures, budget preparation (and execution) systems do exhibit
differences depending on their historic origin. Given the common heritage of many
countries, it is possible to identify four main patterns--francophone, Latin American,
(British) Commonwealth, and transition economies.
To understand the budget preparation process in a given country, it is important to:
assess the basic soundness by judging the budget preparation system against
certain internationally accepted standards or "budget principles";
know where to find the rules governing the budget preparation process; and
from those rules, identify who has the responsibility for what elements of the
budget preparation process.
Recognizing the usefulness of budget principles
Based on the objective macroeconomic assessment of available revenues and
financing, ideally, the expenditure budget should aim to be comprehensive,
transparent, realistic, policy-oriented, and allow for clear accountability in budget
execution. These concepts form a standard by which the soundness of budget systems
can be judged (see Box 1).

Box 1. Assessing the Soundness of the Budget

The soundness of budget systems can be judged by the following:

Comprehensiveness

 Is the coverage of government operations complete?

 Are estimates gross or does netting take place?

Transparency

 How useful is the budget classification? Are there separate economic and functional
classifications that meet international standards?
 Is it easy to connect policies and expenditures through a program structure?

Realism

 Is the budget based on a realistic macroeconomic framework?

 Are estimates based on reasonable revenue projections? How are these made, and by
whom?
 Are the financing provisions realistic?
 Is there a realistic costing of policies and programs and hence expenditures (e.g.,
assumptions about inflation, exchange rates, etc.)
 How are future cost implications taken into account?
 Is there a clear separation between present and new policies?
 How far are spending priorities determined and agreed under the budget process?

 
In most Organization for Economic Cooperation and Development (OECD)
countries, comprehensiveness and transparency are achieved by designing a budget
system with three key characteristics.
Annuality. A budget is prepared every year, covering only one year; voted every year;
and executed over one year. While maintaining the core concept of annual
authorization, this principle has been modified at the preparation stage, such that
most OECD countries now develop the annual budget within a multiyear perspective,
through the preparation of medium-term revenue and expenditure frameworks. A very
few are moving toward determining budget appropriations for more than one year at a
time.
Unity. Revenue and expenditure (as well as borrowing constraints) should be
considered together to determine annual budget targets. The budget should cover all
government agencies and other institutions undertaking government operations, so
that the budget presents a consolidated picture of these operations and is voted on, as
a whole, in the parliament.
Universality. All resources should be directed to a common pool or fund, to be
allocated and used for expenditures according to the current priorities of the
government. In general, earmarking of resources for specific purposes is thus to be
discouraged; but the case of extrabudgetary funds is considered in more detail below.
These three characteristics are essential to ensure that, in budget preparation, all
policy proposals for undertaking government expenditure will be forced to compete
for resources, and that priorities will be established across the whole range of
government operations.
They are usually considered a prerequisite to meeting the first two of the four main
goals of effective public expenditure management noted at the beginning of this
Section: exercising the macroeconomic constraint of affordability on the total, and
ensuring efficiency in the allocation of resources. These characteristics are typically
enshrined in a legal and administrative framework regulating the budget process.

Identifying the responsibilities within the budget system

The powers assigned to the legislative and executive branches, and, within the
executive branch, who does what, essentially define the responsibilities for preparing
the budget (Box 2).

Box 2. The Framework that Regulates the Budget: 

What Do You Need to Know?

The following summarizes some of the key questions on the overall budget preparation
framework.

What is the budget timetable?

How are budgeting powers distributed between the executive and legislative branches?

 legislative power to propose spending

 power of amendment
 one vote--global vote on spending
 executive powers to limit spending below appropriations

How are budgeting powers distributed within the executive?

 number of agencies involved; who does what?

 agenda for setting budget negotiations; how is this determined?
  structure of negotiations--who has veto power?

How are activities funded?

 revenue accounts
 borrowed resources
 extrabudgetary mechanisms
 multiple funds
 contingency funds
 special funds

Any legislative limits on:

 expenditure?
 deficit?
 borrowing?
 carryover of spending authority to next year?

Any earmarking?

 special or hypothecated funds

 constitutional or legal commitments on specific public services (education, health)

Table 1. Potential Weaknesses in Budget Preparation

Ideal Situation Common Weakness Resulting Problems for Those Preparing Budgets

Unified budget with full Dual budget (separate Difficulty in developing a consolidated budget.
coverage. development and recurrent Blurring of capital and current expenditure concepts.
budgets); many With two different budgets it is more difficult to
extrabudgetary funds. enforce expenditure limits or develop a fiscal
adjustment program.

Universality: all revenues go Earmarked funds, especially Rigidity in spending priorities leading to inefficient
into one fund for financing common for financing allocation of public resources. Again, this makes fiscal
central government extrabudgetary funds. adjustment a more difficult task.
activities.

Knowledge and analysis of Lack of data; data not Data in the budget office may be misleading. For
previous year's projected communicated to budget example, actual expenditures are usually different
outturn expenditures; office, or data are not from budgeted expenditures, and the actual number
availability of volume analyzed. of persons employed may be very different from the
indicators. original budget projection.

Use of macroeconomic Inadequate knowledge (or Leads to a bottom-up approach where the budget is
 framework. Separate price incorporation) of determined more by spending-agency requests. This
indices by category of macroeconomic constraints. and inadequate program provision generally lead to
expenditure. Poor estimates of program overspending.
costs.

Multiyear planning. Focus on current year only; no May have a negative impact on fiscal sustainability:
anticipation of future shortsighted policies often cannot be maintained in
circumstances. the long term. Alternatively, a lack of planning means
imminent problems or recurrent consequences of
capital spending are not foreseen.

Procedures for resource No direction in priority Procedures for prioritization are especially important
prioritization implemented setting, or attempt to for meeting deficit targets or spending targets. If
early in budget preparation. prioritize until too late in the priorities are not communicated in a top-down
budget preparation process. approach early in the budget preparation process,
overspending relative to budget is a likely outcome

Budget classification Inconsistent nomenclature-- An economic classification is most useful when

according to implementing for example, mixing designing a fiscal adjustment program. Sometimes
institution (administrative), functional and economic or the only classification available is administrative--by
purpose of expenditure budget nomenclature is not budget institution--so that reducing the budget
(functional), and use of consistent with the chart of requires cuts by institution, and the quality of the
expenditure (economic). accounts nomenclature. fiscal adjustment suffers. Nor is it possible to
understand how expenditures are distributed among
different items or for what purpose.

Box 3. Pros and Cons of Extrabudgetary Funds

Pros

 Can increase efficiency by simulating private market conditions where levels and standards of
service are linked directly to fees or charges.
 Can provide more consistent source of funds for expenditures that yield high benefits yet do
not get much recognition (road maintenance expenditures are a primary example).

Cons

 Can result in a loss of aggregate expenditure control; such expenditure may be outside the
control of ministry of finance.
 Can distort allocation of resources by circumventing the budget process and review of
priorities.
 Earmarked revenues can become entrenched so funding is no longer based on priority
needs.
 Less transparency may lead to inefficiency and/or misuse of funds.
 Can facilitate rent-seeking and abuse of monopoly power.
 Leads to less flexibility at the margin to reallocate when budget is under stress.
  Is incompatible with good cash management practices.