A Merkel & Sarkozy’s Europe? No, Thank You!

Yesterday’s press conference of the German and French leaders to announce their vision of Europe was so dull, leaderless and uninspiring that in itself it was enough to put off any followers of their proposals.

However, their plans for an Euro Zone closer integration are so misguided and meaningless that they need to be denounced as such. They include: a) closer economic integration; b) enforcing compliance with budgetary targets; c) greater fiscal harmonization; and d) better European governance. Let’s examine them one by one.

Full economic integration in Europe has been achieved a long time ago with the implementation of the common market and the single market. All that lacks is a more efficient judicial system to punish attempts by member-states to circumvent the rules when it benefits domestic special interest groups. To have their economic ministers meeting regularly adds nothing. Instead it might increase their propensity to mess with the competition rules whenever it suits them.

Enforcing compliance with budgetary targets by inscribing debt limits in their constitutions is a major mistake as we show in a recent post and the recent history of the US confirms. In short, once you reach the limit there is nothing you can do except to increase the ceiling while creating a lot of uncertainty about the nation’s creditworthiness. The experience in enforcing the Maastricht deficit and debt limits has also shown that France was among the first to bend the rules.

Greater fiscal harmonization on corporate taxation may suit the two countries but it would be a disaster for the rest of Europe. The OECD Tax Database for 2011 shows that France applies a combined corporate income tax rate of 34.4% with a number of special exemptions, while Germany applies a general tax rate of 30.2%. Dividends in France are taxed under a partial inclusion system without withholding, with an overall personal plus corporate income tax rate of 57.8%, while Germany uses a classical system with a withholding rate of 26.4% and a combined personal and corporate income tax rate of 48.6%. Harmonization would give Mr. Sarkozy an electoral boost by reducing tax rates and would allow Mrs. Merkel to get away with a tax rise, but the final result would still be a very high level of taxation. Should other countries follow suit, all the remaining Euro Zone countries would have to raise rates and lose their current tax advantage.

Finally, on European Governance, the two leaders propose an elected president for the Euro Zone area with a mandate of two and a half years and the appointment of an economics minister. This double-headed European Union would aggravate an already messy situation in Europe about who is in charge. What would happen to the head of the Euro Group? Who remembers the names of the current European Union President and Foreign Minister? But, most importantly, it would institutionalize a de facto two-speed Europe that would endanger progress towards an ever closer union.

Overall the meeting of the two leaders was another missed opportunity. The other European leaders should politely say: no thanks!