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Why Incentives Will Drive Europe’s Post-Covid-19 Economic Recovery

Feb. 17, 2021, 8:00 AM

Europe has always represented one of the most interconnected and mobile global polities.

Home to more than 740 million, there are more than 24 spoken languages with more than 44 countries in the region. When you expand the definition of Europe to EMEIA in corporate parlance, that population swells to more than 3.3 billion people.

Migration, in all its forms, has been a central tenet of European identity and trade since well before the days of Marco Polo and Genghis Khan. However, since the Covid-19 pandemic began and border closures and circuit-break lockdowns became the norm, people and capital flows have declined, pushing Europe into a state of winter hibernation as it seeks to fend off Covid-19 and its various mutant strains. These mobility shifts don’t even reflect the impact of constantly evolving geopolitical outlooks and shifting trade agreements in the region.

The International Monetary Fund (IMF) predicts Europe’s GDP will shrink 7.2% in 2020, more than double the 3.5% global average—and higher than any other region except Latin America and the Caribbean. While economists expect the onset of summer and accelerating vaccine distribution timelines to trigger a long-awaited economic recovery and renaissance—a Roaring Twenties if you will, with IMF predictions pegging 5.5% global growth in 2021 and 4.2% in 2022—tax policy, and tax incentives, will become fundamental to the narrative of recovery.

Already, tax policy and tax incentives have played a pivotal role in supporting local economies globally. Tax filing deadlines have shifted, record levels of stimulus have been injected into local markets, and tax cuts and incentives have been issued widely for industries hit hardest by the pandemic: travel, leisure, and hospitality.

In the Europe, in particular, incentives will be instrumental in not only supporting markets with their Covid-19 recovery, but also transitioning to a greener, more digitally enabled bloc. In December 2020, the European Union (EU) agreed to inject $2.18 trillion (1.8 trillion euros) to rebuild a post-Covid-19 Europe. It will be the largest stimulus package ever financed by the EU, with 30% of funds dedicated to fighting climate change as part of the bloc’s desire to become carbon neutral by 2050. As part of the package, ($814.4 billion) (672.5 billion euros) will be dedicated under NextGenerationEU’s Recovery and Resilience Facility in loans and grants to support businesses.

But while incentives are fundamental to the story of growth and competition in a globally interdependent economy, it must be highlighted that governments eventually will need to contend with depleted budgetary resources and look to raise revenues. Here, many deficit-stricken governments will face a paradox: how do they raise more revenue without tamping down much-needed growth? Both the timing and form of future tax increases will need to be carefully considered.

There isn’t a one-size-fits-all approach when navigating an economic recovery, for each market and polity operates differently. All the while, trade patterns continue to shift, supply chains continue to evolve, and vaccine distribution inequalities are seeing asymmetrical recoveries between the developed and developing world, shifting how countries are competing for investment, talent and resources. Already, densely populated megacities that once powered industrial growth are experiencing brain-drains and exoduses on un-precedented scale. Here, smaller cities are seeing huge opportunity for growth and development. There is a fundamental transformation taking place.

Some may argue that after so many months of remote work and confinement, people won’t need an incentive to move and spend. After-all, looking back at pandemics such as the Black Death in the 14th century and the Spanish Flu in 1918, the immediate after-math heralded some of the biggest global economic transformations: first, the Renaissance, second, the Roaring Twenties. However, where people choose to spend their money and where they travel will be largely dictated by what incentives are in play.

Already, we have seen cataclysmic shifts in organizational thinking. Long-term value and sustainability, in particular, are growing in focus. In September 2020, as part of the World Economic Forum’s International Business Council, EY, along with leading organizations globally, signed a set of common reporting metrics designed to integrate environmental, social, and governance (ESG) metrics in standard reporting.

All the while, the pandemic has highlighted just how interconnected and interdependent our communities are. Decisions today cannot be made in isolation with just quarter-to-quarter reporting aimed at satisfying shareholders; they need to consider how they will impact a broader base of stakeholders. People, undeniably, are the key stakeholder throughout these decisions.

For many companies, the great, global “remote work” experiment has highlighted just how important intangible assets such as culture, brand, and workforce are to an organization. Even before the pandemic, it was estimated that up to 90% of a company’s market value could be attributed to non-traditional metrics such as culture.

Following our first-ever virtual aHead of Tax conference in EMEIA, our leaders share how the Covid-19 pandemic has transformed not just tax, but Europe, and what this means for trade, fiscal policy and the region in the “new normal.”

The EMEIA Macroeconomic Outlook

Julie Teigland, EY EMEIA Area Managing Partner

Facilitating an economic recovery remains a key policy priority for leaders in the region, with the European Union (EU) agreeing in late December 2020 to inject $2.18 trillion €(1.8 trillion euros) through its 2021–2027 long-term budget into rebuilding a post-Covid-19 Europe. The challenge, however, for governments across the region will revolve around revenue sources to make it palatable to their voters and equitable to their stakeholders. Revenue sources, for instance, may be linked to a carbon border adjustment mechanism, a digital levy, and the EU Emissions Trading System.

At the same time major changes are underway geopolitically. Portugal has now assumed the EU Presidency from Germany, and over the next four months, negotiations on important tax initiatives will be initiated, including taxation and the environment, the EU’s position on BEPS 2.0, and tax transparency. The election calendar in Europe is undoubtedly going to be influential. All the while, shifting trade patterns dominate discussions, particularly around the details of the UK/EU’s Free Trade Agreement. Equally important is the recent—yet to be ratified—EU/China Comprehensive Agreement on Investments and its potential impact on the EU/U.S. relations. The impact of these changes emphasizes the need to remain vigilant and agile.

The EMEIA Tax and Trade Outlook

Bridget Walsh, EY EMEIA Tax Managing Partner

At the moment, there is a lot of focus on supply chains. When the pandemic first hit, it was about ensuring markets had access to essential goods and services. Now, it is about access to the vaccine. How efficiently healthcare systems can distribute and inoculate their population will determine how quickly those markets will re-open. In the short-term, given the complexity to global supply chains, many companies will continue to conduct detailed analysis and scenario planning this year so they have greater traceability of suppliers, and can continue to build in greater resilience to their supply chain operations. Longer term, companies may choose to onshore, swayed by incentives and the need to de-risk. All the while, we continue to see massive shifts in global trade, whether it is the U.K. leaving the EU, the signing of the Regional Comprehensive Economic Partnership (RCEP) in Asia-Pacific—now the world’s largest FTA—or renewed emphasis on multilateralism by US President Joe Biden’s administration, particularly with the WHO, WTO, and Paris Climate Accords.

As governments throughout EMEIA turn their attention to revenue raising to pay for the record stimulus packages in response to the pandemic, tax is going to play a fundamental role. Tax is already rising on the agenda of company boards as they respond to tax policy changes, tax technology transformation and tax controversy. Long-term value and sustainability will also feature heavily as boardrooms focus on shareholder value and the move to a green recovery, championed by the Secretary General of the United Nations, António Guterres, who called for 2021 to “be the year to reconcile humanity with nature.” With aspects of the EU’s bold European Green Deal starting to be implemented, and the United Nations COP26 climate change summit in November, green taxation is going to take center stage.

The EMEIA Tax Risk and Administration Outlook

Chris Sanger, EY Global Government and Risk Tax Leader and EY EMEIA and UK&I Tax Policy Leader

In the post-pandemic world, it is expected that tax controversy and risk will rise, no doubt spurred by diminished government revenues and a backlog of tax audits and challenges caused by shifting supply chains and trade relationships throughout the pandemic. Since the start of the pandemic, tax authorities have played a pivotal role in supporting organizations—and people. They deferred tax filing deadlines and temporarily paused many tax audits and litigation cases, in part due to disruption caused by remote-work and challenges with mobility. As the global economy acculturates to operating in an increasingly digital environment, and as governments come under increased pressure to raise revenue, it is expected that tax controversy will rise.

Whereas many tax authorities already represent some of the most digitally advanced government bodies, AI and machine learning will only become more fundamental to tax administration in the ‘new normal’. All the while, the pandemic has transformed the scope and remit of tax administration. While tax authorities have played a pivotal role in distributing more than $28 trillion in financial stimulus, they have also rapidly become data centers for governments, assisting some local governments with contact tracing due to the vast swathes of data they possess.

The Future of Work

Seema Farazi, EY EMEIA People Advisory Services Covid-19 Response Leader

Businesses in all sectors and of all sizes are having to reimagine, if not transform, their traditional work practices in the wake of the global pandemic. Many are struggling with changing regulations or reduced demand, whereas others are wrestling with remote-work and digital tools. The entire concept of work as both a place and activity is changing, with demand from employees to “work from anywhere” becoming an increasing reality. Organizations—and people—must carefully consider the associated tax, legal, and payroll implications. For instance, taxation differs from one jurisdiction to the next, as do the pension, healthcare, and employee benefits employees can access. Connect these challenges to Brexit and the evolving immigration landscape across the EU, and cross-border work is taking on a new shape.

As businesses grapple to support employee demands to work “anytime, anywhere” and enhance the employee experience, shifts in working patterns and Covid-19 restrictions are also exposing material differences in the experience of people and organizations. Early evidence by the WTO suggests women will be hit harder than in previous economic downturns, as many women seek to balance work and parenting roles and find themselves in roles that are human-contact heavy, such as education and travel, and work in frontline, essential services that face increased health and safety risks. Organizations must work to continue to ensure that people are front and center of their workforce strategies, and that they continue to prioritize diversity and inclusion efforts to help ensure all employees feel supported and integrated.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.

For all media inquiries, please contact: dan.barabas@uk.ey.com

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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