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Tax/benefit systems and growth potential of the EU

Final Report Summary - TAXBEN (Tax/benefit systems and growth potential of the EU)

The European Union (EU) has ambitious goals in terms of economic performance. The goals are to be reached in combination with social cohesion and sustainable development in terms of environment. The key economic policy instruments to be used by the EU Member States are comprised of taxes and benefits. The economic and political framework for carrying out measures in this field is currently delineated, both encouraged and constrained by factors such as ageing, globalisation and more intense international system competition in tax and social policies.

The project team has used many novel approaches, especially in building new tools that rely on the approach of general equilibrium models so that both the direct and indirect effects of taxation can be analysed. Also new applications of existing large-scale multi-country models were carried out to evaluate the impact of tax policies. In addition, recourse was taken to econometric estimation of the relationships between key economic target variables, on the one hand, and tax / benefit and other fiscal policies and other labour market indicators, on the other, using large international data sets. A number of theoretical approaches on economic policies under the single currency were carried out, too. The analysis covered the EU-15 countries, the New Member States, in some cases other OECD countries as well, and some research efforts made had a global approach to policy making.

Altogether, the project's output was 24 working papers in the five work packages (WPs), and five seminars held, in addition to the final conference. The project delivered, on the one hand, a large number of research insights on actual behaviour related to tax/benefit systems and, on the other hand, reached conclusions which should be taken into account while considering policy-making in, and reforms related to, tax / benefit policies in the EU.

The project's web site at http://www.taxben.org provides detailed information on the whole output and events arranged within the project.

In summary, when it came to employment the project found that the computable general equilibrium models built in the project imply that wage formation is essential in determining the outcome of the tax / benefit policies and their overall effectiveness. The apparent effectiveness of certain policies reached under fixed wages may be quite misleading, because the ensuing reaction of wages may neutralise much of the positive policy effects. However, there are also policy measures whose positive effects are strengthened by the reaction of wage formation. The former include measures affecting labour demand, like reducing the indirect labour costs of firms. The effects of such measures, which reduce wage claims, like benefit reductions, are, however, magnified under bargaining, while with fixed wages their positive effects are only marginal.

With regard to tax competition, CGE model analysis reveals that even a unilateral reduction of the corporate income tax rate is not beneficial for all the EU countries if they have to finance the tax reduction by an increase in the tax rates on labour or consumption. The reduction in the corporate tax rate attracts foreign direct investment and foreign profits. However, the increase in the taxes on labour or consumption dampens the impact on employment, GDP and welfare, and might even offset it.

When it came to productivity, according to pooled panel data estimations and cross-country comparisons of the OECD countries, the growth rate of labour productivity has been affected positively by higher fixed investment, lower inflation, higher research and development (R&D) investment, and information and communication technology (ICT) investment as a percentage of gross domestic product (GDP), a higher share of young adults with at least upper secondary education, and lower product market regulation, and increased exports. In most specifications taxes and gross replacement rates had no statistically significant effect on the productivity growth rates. We found a negative effect from taxes and a positive one from gross replacement rates when they appeared together with fixed investment or inflation. However, with this evidence we conclude that taxes and gross replacement rates are unlikely to have had an effect on productivity growth.

Under the macroeconomics of tax systems, the theoretical modelling of the Monetary Union shows that if the economies are mainly hurt by demand shocks, then flatter tax systems tend to destabilise output whereas indexation of taxes on prices tend to stabilise it. If the economies are mainly hurt by supply shocks, then the progressiveness of taxation has little impact on output stability. On the whole, the move towards flatter tax systems would likely lead to more unstable output in the Euro area. And finally with regard to energy taxation, using two large-scale models of the global economy in combination shows that in an optimal emission policy over the next 100 years developing countries reduce considerably more their emissions than industrialised countries. This result is mainly driven by the share of coal in the baseline fuel use mix. The reduction in production differs between sectors, with a similar pattern in all regions. Plausibly, the fossil fuel sectors are most affected, whereas the non-energy sectors hardly decline at all.