So who's after our taxman?

Britain's fiscal system will be run by foreigners, say the Euro- sceptics. What nonsense, writes Yvette Cooper

What a palaver. When our sister paper, the Independent, revealed that plans were afoot deep in the heart of Europe for closer integration of tax and social security systems, the politicians went into spasm. The Euro-enthusiasts went all wobbly and the Euro-sceptics started spinning.

There's nothing like tax to hit a British nerve. The idea that British general elections would never again hinge on politicians' promises of tax cuts seems to trouble us deeply. Losing the Queen's head from the coins we clunk in our pockets upsets us far less than the thought of bidding farewell to the Chancellor's battered Budget briefcase. Margaret Thatcher made it clear that, "the ability to set one's own levels of taxation is a crucial element of national sovereignty."

But last week the Euro-sceptics were manipulating our attachment to the British tax system to provoke hostility towards a single currency too. "If you do not want European income tax," wrote John Redwood in Friday's Independent, "then do not surrender the pound, for the one follows the other as night follows day."

Slither, slither, his argument runs, down the slippery slope. Start with a single market and somehow you find yourself slipping towards a single currency. Slither helplessly into a single currency and you supposedly surrender all control of fiscal policy too. Before you can do anything about it, you are skidding into a single uniform tax and benefit system, then whoops, you land with a bump in a single country called Europe.

But this is nonsense - at least the economics of it are nonsense. The political momentum towards deeper integration may yet prove extremely strong, leaving countries that want to go so far and no further in a difficult position. But the economics are rather different.

For a start, a single currency does not demand a single tax and benefit system. Although the proposed stability pact will mean restrictions on national government deficits, the arrangements will leave plenty of room for manoeuvre, with discretion placed in the hands of finance ministers. There is nothing in EMU that implies co-ordination of tax rates and benefit levels.

EMU or no EMU, there will be pressure for greater co-ordination of certain taxes in Europe. Tax harmonisation has bounced on and off the European agenda for decades now, as economists, accountants and policy makers considered how far different national structures should be co-ordinated to make the single market - rather than the single currency - work.

The theory runs as follows: the purpose of the single market was to encourage the free, unfettered movement of investment, people and products around Europe - to improve economic efficiency and growth. The trouble is, things that move are much more difficult to tax than things that stand still. For example, it is hard to raise taxes on earnings, if your workers can easily move to a lower tax zone. So, to the extent that a single market encourages the things we tax to move across borders, the pressure for tax harmonisation is bound to grow.

In some areas, European countries clearly will have an interest in co- ordinating their tax structures. Capital flows pretty fast across borders already. A single currency will make it even less costly to switch cash from place to place to find the lowest tax rate; we will no longer have to worry about the fee for converting currencies or the risk of depreciation.

Companies are increasingly mobile too. A new plant in Alsace-Lorraine or across the border in Germany may not make too much difference as far as the investing company is concerned. But if one country has much higher corporation tax, that could tip the balance. None of this means that countries within a single market, or even within a single currency zone, need have identical and unified tax systems. As the economist Jonathon Leape of the London School of Economics explains, the wide variety of tax and accounting structures across Europe makes complete integration "an ambitious and costly project". Nevertheless, there is a case for co-ordination.

John Redwood can't blame the European Union entirely for these new constraints. Capital and companies can dance across borders right around the world, so the trend towards lower (or co-ordinated) taxation is likely to be global. More important, as Andrew Dilnot, director of the Institute for Fiscal Studies, points out: "The argument for co-ordinating the main levels and structure of personal tax is much weaker than for taxing mobile things." Personal tax is clearly Mr Redwood's real concern. That, after all, is the one that British voters are most sensitive to.

But here, European governments are likely to retain considerable flexibility and freedom to manoeuvre for a long time to come. Why? Because people - especially British people - don't bounce easily across borders in the same way that goods, companies and money seem to. If France cuts its income tax, there will not be a mass exodus of Brits across the Channel seeking work. And vice versa. So long as there are strong linguistic and cultural differences, countries can get away with considerably different tax and spending packages.

Shoppers are slightly more mobile, however. Countries are already finding that high indirect taxes push sensitive consumers across the border to buy. Just listen to the cries from the British drinks industry, which has been calling for tax harmonisation with Europe. This kind of pressure for co-ordination is not driven by Eurocrats but by British companies protecting their business and a sovereign parliament protecting its tax base.

Admittedly as labour mobility increases, the pressure to co-ordinate income tax and benefit structures is likely to grow a little. But this kind of tax and benefit tourism is so far from the constrained European labour market we currently live in that it is not worth the Euro-sceptics getting agitated about. Moreover, if we ever reach a Europe in which labour market mobility is so great that we need identical tax and benefit systems, the chances are these multi-lingual Euro-trotting citizens won't be too worried about the sovereignty of the old-style nation state anyway.