How the EU works: what is the customs union?
The EU’s customs union was first established in 1968 by the six founding member states of the current EU (Belgium, France, Germany, Italy, Luxembourg and the Netherlands).
Its main purpose was to remove some of the barriers to trade between member states and to act as a step towards closer political and economic cooperation.
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What the customs union is
The Treaty on the Functioning of the EU sets out in detail the powers and procedures of the EU institutions. It has two main provisions relating to the customs union:
First, for trade in goods within the union, it bans taxes on imports and exports (known as tariffs).
Second, for imports from the rest of the world, all customs union members charge the same set of tariffs – known as a common external tariff .
Services aren’t directly covered since tariffs don’t apply to them.
A common external tariff is the main distinctive feature of a customs union. It means that there is a common tariff border across the whole EU. It also means the ability to set those tariffs is transferred from member states to EU institutions.
Other important features include the sharing of revenue collected from tariffs – almost 80% goes to the central EU budget – and stopping member countries from charging retaliatory duties against each other in instances of unfair trade (such as flooding the market with an under-priced product).
The customs union is different to the single market which establishes common rules and regulations to promote the free movement of goods within the Union.
The customs union simplifies trade between its members
If a country has no agreement with the EU, tariffs apply. If a country has a free trade agreement (FTA) with the EU, tariffs can be reduced or removed.
But goods imported into the EU using a free trade agreement still need to provide proof of where and how their goods were made. This is known by the term ‘rules of origin’ which is intended to ensure that the correct tariff is levied and only products coming from the FTA partner benefit from the lower tariff. Different products have different rules agreed between the parties setting out criteria for judging where it came from.
The average car made in the UK purchases 44% of its components from UK suppliers. But the proportion of this actually made in the UK is somewhere between 20% and 25%. For an average FTA it would need to meet a 55–60% threshold to qualify for whatever reduction in tariffs had been agreed.
A customs union not only removes tariffs, it also eliminates the need to provide this proof.
By ensuring that members have the same external tariff, any components will either have already paid the tariff to enter or will have originated inside the customs union.
This is of significant benefit for customs union members. According to the Government’s 2013 Trade and Investment Balance of Competence Review, the economics literature identifies trade costs from rules of origin ranging from four percent to perhaps 15 percent of the value of trade.
But it doesn’t mean by itself that border checks are removed
A common external tariff doesn’t avoid the issue of a ‘hard border’ because tariffs are only one of the issues that affects free movement of goods. Regulatory checks for compliance and VAT are also carried out. The abolition of checks at the border did not come about until advent of the single market in 1993.