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 European tax reforms to: a) check consistency of design b) assess influence of EU specific features

Outline of presentation 1) Review motivations of reforms 2) Discuss expected effect of EU features 3) Description of reforms 4) Assess consistency of reforms with motivations 5) Examine evidence of EU features effects

Motivations (i): The timing of reforms At the end of the 1990s almost all EU Governments announced a reform Factors accounting for clustering: 1) Common unemployment and growth problems (Lisbon Council, 2000) 2) Cyclical upturn  margins for tax cuts 3) Elections (political opportunism)

announcement of reform elections Motivations (ii): Tax reforms and elections

Motivations (iii): Policy arguments Analyse Governments’ declared intentions (Stability Programmes) Results: 1) all use supply-side arguments 2) low weight to equity considerations

Motivations (iv): Some examples 1) Spain: “reform designed to boost the supply side...” 2) The Netherlands “tax reform expected to push up supply of labour…” 3) Germany “... for promotion of growth and employment…” “... for promotion of growth and employment…” 4) Greece “…to increase business activity and labour supply…”

Motivations (v): The tax burden in the EU Motivations hardly surprising: a) in the 1990s EU growth is relatively low and unemployment relatively high b) tax burden rising from the 1960s in the EU c) 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 * Using the “Prescott Index”:

EU specific features (i) 1) EMU Fiscal Rules 2) Increasing economic integration (tax competition) 3) Need for national fiscal stabilisation in EMU 4) Population ageing (sustainability)

EU specific features (ii): expected effects Likely: 1) Fiscal Rules: limit the effect of tax reform on fiscal balances 2) Integration: link between taxation and mobility + clustering of tax reforms Possibly: 3) Stabilisation: tax cuts accompanied by changes to welfare benefits 4) Ageing: tax cuts tailored to provide incentives to labour market participation

Description of reforms a) reduce average and marginal rates on labour (including social security contribution) b) cuts targeted at low-to-middle incomes (+ reform of unemployment benefits) c) clustering d) cuts to corporate taxation also common d) modest quantitative impact e) enacted when expect deficit improvement g) funding relevant in declared intentions h) gradual implementation

Design-Motivation Consistency reduction of average and marginal rates on labour cuts targeted at low-to-middle incomes  good matching of design and motivations However modest quantitative impact  reforms not effective

Effects of EU specific features (i) a) fiscal rules  modest quantitative impact of reforms b) fiscal rules (expect a deficit improvement) + tax competition  clustering of reforms? c) fiscal rules  funding relevant in intentions + gradual implementation d) stabilisation + ageing  tax reform targeted at low incomes + accompanied by changes to benefits?

Effects of EU specific features (ii) However: fiscal rules + risks for sustainability did not manage to induce reforms in expenditure programs to accompany tax cuts

Summing up * Tax reforms design consistent with motivations * Reforms may fail to be effective as fiscal rules: a) avoid large deterioration of budget balances BUT b) do not force reforms of expenditure programs