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Most Germans would probably welcome lower taxes. But Gerhard Schröder is preaching against it. For months now, the Chancellor has taken every opportunity to admonish his new E.U. neighbors to the east for their low tax rates. In Schröder's eyes, they are freeloaders, taking E.U. aid to build up their economies while stealing business from nations like his. "It is certainly unreasonable that we finance an unbridled tax competition among each other via the budget of the European Union," he said in Poland on May 26. Germany is expected to press its case again in September at a meeting of E.U. ministers in the Netherlands.

Is Schröder's fear justified? It's true that many of the new E.U. states look like tax paradises compared to Germany or France. In January, Poland dropped its corporate-tax rate from 27% to 19%. Slovakia this year implemented a flat income tax of 19%. The average corporate-tax rate in the 10 new members is 21.3%, while it is nearly 30% in the rest of the E.U. It is 38% in Germany and 34% in France.

That's why many believe that firms may flee France and Germany and head east. Dalia Marin, an economics professor at the University of Munich, says that German multinationals created some 780,000 jobs in Eastern Europe between 1990 and 2001, resulting in a net loss of 90,000 jobs in Germany.

Of course, companies weigh more than the tax rate when deciding where to set up shop. According to Marin, taxation ranked ninth, behind factors like market access and production costs. But she expects German jobs to keep heading east. "The past is a good indicator for the future," she says. Paul Barnes, COO of KPMG Tax Services for Central & Eastern Europe, is working with a Bavarian client who tells him only two things keep him from moving his factory to Poland: affinity for the town where his factory is based and the trade unions. "He says, 'If I just look at the economics, it's a no-brainer. What it costs me to employ a German for one hour, I get a Polish skilled worker for a day plus I pay 19% tax,'" says Barnes. "He is not going to close his factory, but his next investment is going to be in Poland."

From Eastern Europe, calls for harmonization sound like sour grapes. "We look at the German economy with a sense of envy, its advanced technology and its leading position as an exporter," Polish Prime Minister Marek Belka said in May. "Once we get closer to such a level it will be easier to discuss." Others suggest Germany should follow the East's lead. Branislav Durajka, tax chief of the Slovak Finance Ministry, says that since the flat tax was implemented, higher receipts from consumption and value-added tax have more than made up for a slight shortfall in personal income tax. "We could give some advice to [Germany and France]," he says. "The lowering of tax to around 20% doesn't lead to a decline in budget revenue — on the contrary."

It certainly caught Austria's attention. In 2005, its corporate-tax rate will drop from 34% to 25%. "When corporate income tax is 16% in Hungary [and] 19% in Slovakia ... then Austria had to do something," said Finance Minister Karl-Heinz Grasser. The country's Socialists and Greens have criticized the decision for burdening pensioners and favoring corporations over small businesses, but the private sector cheered — and inquiries from foreign companies about setting up in Austria skyrocketed.

Perhaps that's what has Schröder so worried. Suzanne Rosselet of the IMD World Competitiveness Yearbook suggests that calls for tax harmonization have the problem backwards. "It's a fog behind which they are trying to hide the true problems in their own economies," she says. "They need to reform themselves before they put the blame on all the other economies."

• JAN STOJASPAL
• The German chancellor is a major player in the fight against tax cuts