Fabrizio Balassone, Daniele Franco, Alessandra Staderini (*)

Tax Policy in EMU: a Preliminary Assessment

(*) Banca d’Italia - Research Department

Aim of the paper

Analyse motivations of recent Analyse motivations of recent European tax reforms to:European tax reforms to:

a) check consistency of designa) check consistency of design

b) assess influence of EU specific b) assess influence of EU specific featuresfeatures

Outline of presentation

1) Review motivations of reforms1) Review motivations of reforms

2) Discuss expected effect of EU features2) Discuss expected effect of EU features

3) Description of reforms3) Description of reforms

4) Assess consistency of reforms with motivations4) Assess consistency of reforms with motivations

5) Examine evidence of EU features effects5) Examine evidence of EU features effects

Motivations (i): The timing of reforms

At the end of the 1990s almost all EU At the end of the 1990s almost all EU Governments announced a reformGovernments announced a reform

Factors accounting for clustering:Factors accounting for clustering:

1) Common unemployment and growth 1) Common unemployment and growth problems (Lisbon Council, 2000)problems (Lisbon Council, 2000)

2) Cyclical upturn 2) Cyclical upturn margins for tax cuts margins for tax cuts

3) Elections (political opportunism)3) Elections (political opportunism)

1997

1998

1999

2000

2001

2002

2003

1997 1998 1999 2000 2001 2002 2003

ann

oun

cem

ent

of r

efor

m

elections

Motivations (ii): Tax reforms and elections

Motivations (iii): Policy arguments

Analyse Governments’ declared Analyse Governments’ declared intentions (Stability Programmes)intentions (Stability Programmes)

Results:Results:1) all use supply-side arguments1) all use supply-side arguments

2) low weight to equity considerations2) low weight to equity considerations

Motivations (iv): Some examples

1) Spain: 1) Spain: ““reform designed to boost the supply side ...”reform designed to boost the supply side ...”

2) The Netherlands2) The Netherlands““tax reform expected to push up supply of labour…”tax reform expected to push up supply of labour…”

3) Germany3) Germany ““... for promotion of growth and employment…”... for promotion of growth and employment…”

4) Greece4) Greece“…“…to increase business activity and labour supply…”to increase business activity and labour supply…”

Motivations (v): The tax burden in the EU

Motivations hardly surprising:Motivations hardly surprising: a) in the 1990s EU growth is relatively low and a) in the 1990s EU growth is relatively low and

unemployment relatively highunemployment relatively high

b) tax burden rising from the 1960s in the EUb) tax burden rising from the 1960s in the EU

c) although empirical evidence is ambiguous ac) although empirical evidence is ambiguous a link between the two was suggested link between the two was suggested

Motivations (vi): The tax burden in the EU

* Concern especially over high tax wedge on labour * Concern especially over high tax wedge on labour * Using the “* Using the “Prescott Prescott Index”: Index”:

1,3

1,4

1,5

1,6

1,7

1,8

1,9

2,0

2,1

2,2

2,3

1980 1984 1988 1992 1996 2000

EU Average

USA

Japan

EU specific features (i)

1) EMU Fiscal Rules1) EMU Fiscal Rules

2) Increasing economic integration 2) Increasing economic integration (tax competition) (tax competition)

3) Need for national fiscal stabilisation 3) Need for national fiscal stabilisation inin

EMU EMU

4) Population ageing (sustainability)4) Population ageing (sustainability)

EU specific features (ii): expected effects

Likely:Likely:1) Fiscal Rules: limit the effect of tax1) Fiscal Rules: limit the effect of tax reform on fiscal balances reform on fiscal balances2) Integration: link between taxation2) Integration: link between taxation and mobility + clustering of tax reforms and mobility + clustering of tax reforms

Possibly:Possibly:3) Stabilisation: tax cuts accompanied by3) Stabilisation: tax cuts accompanied by changes to welfare benefits changes to welfare benefits4) Ageing: tax cuts tailored to provide4) Ageing: tax cuts tailored to provide incentives to labour market participation incentives to labour market participation

Description of reforms

a) a) reduce average and marginal rates on labour reduce average and marginal rates on labour (including social security contribution)(including social security contribution)

b) b) cuts targeted at low-to-middle incomes cuts targeted at low-to-middle incomes (+ reform of unemployment benefits)(+ reform of unemployment benefits)

c) c) clusteringclustering

d) d) cuts to corporate taxation also commoncuts to corporate taxation also common

d) d) modest quantitative impactmodest quantitative impact

e) e) enacted when expect deficit improvement enacted when expect deficit improvement

g) g) funding relevant in declared intentionsfunding relevant in declared intentions

h) h) gradual implementationgradual implementation

Design-Motivation Consistency

reduction of average and marginal rates on labour reduction of average and marginal rates on labour cuts targeted at low-to-middle incomes cuts targeted at low-to-middle incomes

good matching of design and motivationsgood matching of design and motivations

HoweverHowevermodest quantitative impact modest quantitative impact

reforms not effectivereforms not effective

Effects of EU specific features (i)

a) a) fiscal rulesfiscal rules modest quantitative impact of modest quantitative impact of reforms reforms

b) b) fiscal rulesfiscal rules (expect a deficit improvement) (expect a deficit improvement) + + tax competitiontax competition clustering of reforms? clustering of reforms?

c) c) fiscal rulesfiscal rules funding relevant in intentions funding relevant in intentions + gradual implementation + gradual implementation

d) d) stabilisation stabilisation + + ageingageing tax reform targeted at low incomes tax reform targeted at low incomes + accompanied by changes to benefits? + accompanied by changes to benefits?

Effects of EU specific features (ii)

However:However:

fiscal rules + risks for sustainability fiscal rules + risks for sustainability did not manage to inducedid not manage to inducereforms in expenditure programsreforms in expenditure programsto accompany tax cutsto accompany tax cuts

Summing up

* Tax reforms design * Tax reforms design consistent consistent with motivationswith motivations

* Reforms may * Reforms may fail to be effectivefail to be effective as fiscal rules: as fiscal rules: a) avoid large deterioration of budget balances a) avoid large deterioration of budget balances BUT BUT b) do not force reforms of expenditure programs b) do not force reforms of expenditure programs