Siim Kallas got a strong message from Brussels on his first trip there as Estonia's prime minister: Change your corporate tax system.
European Commission President Romano Prodi told Kallas on March 7 that Estonia should change its popular policy of not taxing reinvested corporate taxes.
"It is clear that this has created problems for some member countries because it is completely outside the strategy of the European Union," said Prodi.
Analysts say the tax strategy is one reason the Estonian economy posted strong growth and low unemployment last year, particularly in the fourth quarter, despite the souring global economy.
Estonia eliminated taxes on reinvested corporate profit in 2000.
Kallas had heated discussions about the strategy with EU Commissioner for Enlargement Guenter Verheugen and Taxation Commissioner Frits Bolkestein, Radio Free Europe reported.
He said direct taxation falls outside the realm of EU negotiations.
"In our opinion there is no need to discuss the Estonian income tax system at the accession talks, but the question keeps cropping up," Kallas was quoted as saying. "The inclusion of the income tax issue would not be practical, as this topic could seriously delay talks. We would not be prepared to contemplate solutions to any of the other issues within the taxation chapter."
The EU typically only monitors indirect taxes such as value added taxes and tariffs. Countries themselves are usually free to determine their own coporate taxation systems.
Prodi and the European Commission have been heavily criticized by member states in the past for trying to oversee tax policy.
But in Estonia's case pressure is being brought on by several members, including France, Spain and Italy.
"The formal policy of the European Union has until today been that direct taxation is the sovereign right of states," said Kallas. "The income tax of investments is formally not touched upon in the negotiations process."
Prodi said the commission's stand was not against Estonia but for a more harmonized tax system for the EU.
"It is obvious that it has created problems for some member states since it is different from the joint strategy of the EU," said Prodi. "The problem is that we have to bring into agreement totally different approaches.
"I am not saying that we need to do everything the same way, I am just saying that since we have to live in a single market, we need to have common rules."
Prodi's comments have met with disdain not only from Kallas but elsewhere in Estonia.
Andres Kuningas, head of the international affairs department at the Ministry of Finance, said Estonia's tax policy was approved by the International Monetary Fund and was in accordance with the EU's "code of conduct," under which member states were pledged not to violate honest competition in corporate taxation.
"The Estonian taxation system is a symbol of the country," said Kuningas. "Our standpoint is that the legislation should not be changed. It does not contradict EU terms."
The respected business newspaper Aripaev wrote in a March 11 editorial that if the EU made the country's admission to the EU contingent on changing the corporate tax policy then it should pull out of negotiations now.
"Estonia has not created for itself unjustifiable benefits and is not requesting special treatment," the editorial read. "It has only removed obstacles that were restricting faster growth.
"If such simple truths are not understood by Eurocrats then maybe Estonia should try to explain them more slowly."