Outlook: Euro tax

THE CHANCELLOR has got himself into a bit of a hole over that irritating German proposal for a European wide withholding tax on investment income. The wretched thing is on the agenda for an informal meeting of European finance ministers in Dresden this weekend, and jolly uncomfortable the Treasury is about the whole thing too.

In the City, the proposal is causing much gnashing of teeth and it has been leapt on by the Eurosceptic press as a cause celebre. According to some, the tax will force the entire Eurobond industry to migrate from London to kinder tax regimes, with the loss of thousands of British jobs.

This might be an unduly alarmist view but it is certainly the case that if imposed, the tax would partially erode the City's competitive advantage. In an electronic world where it is becoming increasingly easy to locate business in one of any number of international financial centres, it is crucial that the City hangs onto as much of a competitive edge as it can.

The perceived seriousness of this threat has prompted the British government to take a tough (or tough-ish) line. Gordon Brown, we are told, will not agree to anything that harms the City. However, neither is Mr Brown keen to use his powers to veto the tax unless absolutely necessary.

This has all led to talk of compromise, with the favoured plan, at least until very recently, being to discriminate between wholesale and retail investors by imposing a threshold of 40,000 euros, over which transactions would be tax-exempt. In theory this would trap rich tax dodgers while leaving the wholesale market unaffected.

In practice, it would probably do nothing of the sort. Canny retail investors could avoid the tax by joining forces until the combined value of their transactions exceeded the threshold. This gives the Chancellor a possible let-out. If the effectiveness of the legislation is open to question, then ministers are unlikely to back it.

So where does this leave us? One of two things could happen. First, someone could come up with a brilliant compromise - which seems rather unlikely given the poor standard of the solutions that have been proposed so far. Second, and far more the most likely, is that alternative proposals will be discussed, plans drawn up, and consultations made, until the German presidency of the Commission has passed. Playing the whole thing off into the long grass seems to be the Chancellor's best hope of avoiding use of the veto.