What is Taxation?

Taxation is the fundamental means by which governments generate revenue to fund public services and infrastructure. It serves as the financial backbone of governance, enabling states to provide essential services such as education, healthcare, social welfare, security, public infrastructure, and research.

Functions of Taxation:

1. Financing Public Services – Governments rely on tax revenue to fund schools, hospitals, emergency services, defense, and public institutions.
2. Economic Regulation – Tax policies can be used to encourage or discourage certain behaviors, such as reducing carbon emissions through green taxation or promoting investment through tax incentives.
3. Income Redistribution – Progressive tax systems ensure wealth is more equitably distributed within society, reducing income disparities.
4. Encouraging Investment and Innovation – By offering tax credits or deductions for research and development, governments incentivize businesses to innovate and expand.
5. Maintaining Market Stability – Governments use taxation to regulate inflation, employment, and consumption, ensuring economic stability.

In the EU, nearly 90% of public revenue comes from taxation, making it essential for national governments to establish efficient and sustainable tax collection mechanisms. If a country fails to generate sufficient tax revenue, it may have to borrow funds, leading to debt accumulation and financial instability.

Types of Taxation in the EU

EU taxation is broadly categorized into direct taxation and indirect taxation. While direct taxation remains a national competence, EU regulations play a role in harmonizing indirect taxes to ensure a level playing field across the Single Market.

1. Direct Taxation

Direct taxes are levied on individuals and businesses, affecting their income, profits, or property. 

These include:

• Personal Income Tax – Tax on salaries, wages, and other forms of personal earnings.
• Corporate Profit Tax – Tax imposed on company earnings.
• Capital Gains Tax – Tax on profits from asset sales, such as stocks or real estate.
• Wealth and Property Taxes – Levies on assets such as real estate or inheritances.

The EU has limited legislative power in direct taxation. However, it ensures that national tax laws align with EU treaties, particularly regarding cross-border economic activity, tax evasion, and aggressive tax planning. Any harmonization efforts in direct taxation require the unanimous approval of all member states.

2. Indirect Taxation

Indirect taxes are imposed on transactions rather than income or profits. These include:

• Value Added Tax (VAT) – A consumption tax applied to goods and services.
• Excise Duties – Levies on specific products such as alcohol, tobacco, and energy.
• Customs Duties – Taxes on imports from outside the EU.

Unlike direct taxation, the EU plays a more active role in harmonizing indirect taxes to prevent distortions in competition. The EU VAT Directive establishes a common framework for VAT, ensuring that businesses operate under similar conditions across member states.

Why is an EU Tax Policy Needed?

While taxation remains a national competence, there is a strong need for EU-wide tax coordination. Taxes influence investment decisions, trade, and economic activity, meaning that uncoordinated tax policies could create disparities, hinder market integration, or lead to tax avoidance.

Reasons for EU Tax Policy Coordination:

1. Ensuring Fair Competition – Harmonized tax rules prevent tax dumping, where countries lower tax rates to attract businesses at the expense of fair competition.
2. Supporting Economic Growth – Coordinated tax policies reduce compliance costs for businesses operating across borders, encouraging investment and trade.
3. Combatting Tax Evasion and Avoidance – The EU works to close tax loopholes that allow companies and individuals to shift profits to low-tax jurisdictions.
4. Ensuring Stable Public Finances – Coordinated taxation policies help member states generate sustainable revenues while avoiding excessive debt accumulation.
5. Addressing Global Economic Challenges – Tax policies must adapt to shifts in digitalization, climate change, and geopolitical instability.

The EU’s main objectives for taxation include:

• Ensuring fairness – Reducing tax disparities that create an uneven playing field.
• Supporting sustainable growth – Aligning taxation with economic and environmental goals.
• Generating revenue for the EU budget – VAT-based contributions partially fund the EU budget.

EU’s Recent Actions on Taxation

To modernize tax policy and address emerging challenges, the EU has taken several legislative and policy measures, including:

1. Avoiding Double Taxation in Cross-Border Investment

Investors who hold securities in another EU country may face double taxation, requiring them to submit refund claims that are often complex and time-consuming.

To address this, the FASTER Directive (adopted in December 2024) introduced:

• Fast-track tax relief procedures – Allowing investors to reclaim withholding taxes more efficiently.
• Common EU digital tax residence certificate (eTRC) – A standardized digital certificate simplifying tax relief claims.
• Reporting obligations for financial intermediaries – Enhancing transparency and fraud prevention.

2. Reducing Compliance Costs for Businesses

The Business in Europe: Framework for Income Taxation (BEFIT) initiative (proposed in 2023) seeks to:

• Establish a single set of tax rules for corporate groups operating in multiple member states.
• Introduce a shared tax base to reduce administrative burdens.
• Apply to large businesses with revenues above €750 million while allowing medium-sized firms to opt in.

3. Combatting Tax Avoidance

The EU actively fights tax evasion through:

• The Code of Conduct on Business Taxation – Preventing harmful tax competition.
• The EU List of Non-Cooperative Jurisdictions – Blacklisting tax havens that refuse to align with global tax governance standards.

4. Taxation in the Digital Age

With the rise of digital business models, traditional tax rules struggle to capture revenue from digital services. The EU has prioritized:

• Fair taxation of digital companies – Ensuring that online platforms and tech giants contribute fairly.
• Enhanced tax reporting obligations for online businesses.

5. Modernizing the VAT System

The VAT in the Digital Age (ViDA) Package (November 2024) introduced:

• E-invoicing and digital reporting obligations – Making VAT procedures fully digital by 2030.
• Extended “One-Stop-Shop” systems – Simplifying cross-border VAT compliance for businesses.
• New VAT rules for online platforms – Requiring companies like Airbnb and Uber to handle VAT obligations.

Additionally, on February 18, 2025, the Council adopted an electronic VAT exemption certificate, eliminating outdated paper-based exemption claims.

The Council as the Sole EU Legislator on Tax Matters

Unlike other policy areas where the European Parliament and Council co-legislate, taxation remains an exclusive competence of the Council of the EU. 

This means:

• All tax decisions require unanimity among the 27 member states.
• The European Commission can propose tax legislation, but it cannot pass it.
• The European Parliament has only an advisory role in tax matters.

The Council’s role ensures that national governments retain sovereignty over taxation while fostering a balanced, unified approach to tax policy at the EU level.

Conclusion

EU tax policy is a complex but essential framework that balances national sovereignty with the need for harmonization. While direct taxation remains largely a national competence, the EU plays a crucial role in shaping indirect tax policies, combating fraud, and adapting to economic and technological developments. With the rapid digitalization of economies and the ongoing globalization of trade, tax policy coordination will remain a key priority for the EU in the years to come.