IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Introduction by Pierre Garello, Director of the Research Department of IREF
We already knew what the general situation and trends are in the EU. Namely, that the EU- 27 is still the region of the world with the highest fiscal burden, that situations differ greatly among EU member states (with new member countries having lower fiscal burden) and that some trends can be found in the evolution of the tax-mix with, for instance, a weak tendency to replace corporate income tax and labour tax with consumption tax. The reports presented here give life to those statistics. They reveal what were the priorities and constraints of the government in each country?
They point out to the structural weaknesses of each country’s fiscal system and give a critical presentation of the novelty recently introduced. Let me quickly give you a sample of what you will find in the following pages. We start with a report from Jan Schnellenbach who severely criticizes the proposed reforms of German inheritance tax law. More generally, even if the desire to increase tax revenues in order to get out of the public finance crisis was understandable, he points to the “recent symptoms of distributive populism” found in Germany. In the Netherlands, on the other hand, Jan Schnellenbach observes that a lot has been done to reduce the tax burden of corporate tax (introducing, for instance, a “patent box” and a “group interest box”). Pierre Bessard reports on Switzerland starting with the story of the canton of Obwalden which, after having its proposal for a regressive income tax rejected by the constitutional court, switched to a 12% flat tax (supported by 91% of the voters) that results in an even lower fiscal burden. He reports also on the battle opposing EU and Swiss authorities over what constitutes State aid. According to Juan José Rubio Guerrero and Julio Pomés Ruiz, Spain just missed the opportunity to further reduce taxes and boost the economy. They look in details to the various schemes related to the aging problem. Also, in their view, the 2006 reform of income tax penalizes small savers and benefits speculators. Curiously, even long term savings receive no favor: “The maximum limits for contributions to pension plans are to be significantly reduced as from 2007”. recent reforms of corporate income tax deserve, according to them, the same judgment: the law does not introduce any substantial change and the changes appear inappropriate to the present situation of the Spanish economy. From the opposite corner of Europe, Ruta Vainiene tells us how Lithuania benefits from tax competition: “If it was not for international tax competition, Lithuania would impose progressive personal income tax, higher corporate income tax. There would be no discussions on social security contributions ceiling.” Still, the political mood is to increase taxes rather than lower them, even though there are clear signs of a Laffer’s curve phenomena taking place: Lithuania has rather high tax rates and low revenues. In Slovakia, the 2006 change of government (from free-market to socialist) has left taxation largely unchanged, but, says Jiri Schwarz, the tax burden is nonetheless expected to increase in the coming years. Also, an interesting debate is taking place to decide whether one should aim at the most possible neutral system or keep using deductions as incentives. The situation issomehow different in the Czech Republic: the new government would like to reduce taxes but the level of public deficits is not making the task easy. Some reforms appear to benefit more the high-income households. In Denmark, explains Jacob Breastrup, 2007 was marked by a change in municipal structure. More changes on the tax front are coming in 2009, the mood being rather in favor of tax cuts. The same mood prevails in Sweden, where the new center-right government has abolished wealth tax. Meanwhile, Norway is taking the opposite direction: the tax structure has remained basically unchanged since 2004 and the base for the wealth tax has been broadened. Reporting on tax changes in France, Vesselina Spassova focuses her analysis on the new law aiming at putting French citizen back to work (“TEPA law”). A set of tax incentives has been included in that law such as making overtime work non-taxable, strengthening the “fiscal shield” or reducing death tax for close relatives. Their complexity could lead, however, to disappointing results. Corporate income tax and wealth tax are largely unchanged. The pending question is whether those tax incentives will generate enough growth to cover State deficits and repay a huge pubic debt. Chances are that they will not. Italy’s tax orientations have been fluctuating following changes in political majority. In the late 90s, the center-left, Prodi’s coalition has promoted a new dual-income tax (DIT) and a new regional tax (IRAP) for businesses. Those innovations have then been criticized by the Berlusconi’s team for introducing various undesired effects (such as increasing labor cost, or introducing biases in companies’ financial strategies). Personal income taxation has also changed according to the dominant political color. In 2007, says Giorgio Brosio, tax revenues surged (as in 2006), this being probably due to the success of policies designed to fight tax-evasion. Finally, you will find below reports on the fiscal systems of the two new comers in the European Union: Romania and Bulgaria. In both cases, as you will see, a wind of rapid change is blowing, but there is still room for improvement. Romania got a new tax code in 2003 and, since 2004, has a flat corporate and income tax at 16% (the socialists, if elected in 2008, threaten to move back to progressive taxation). But, according to Radu Nechita, one should not be fooled by such low tax rates: the tax burden is still heavy when taking into account the uncertainty, incoherence, instability and even the absurdity of tax administration. The retirement pensions are problematic, but in 2007 the first reforms have been implemented. With a 10% (truly) flat tax on corporate and personal income, Bulgaria is ahead of tax competition in the EU and even in the world. Peter Ganev describes the most likely impact of those cuts. On the other hand, indirect taxation and social contributions remain rather high (compared to countries such as Ireland). Indirect taxation (VAT and excises) are kept high due to EU harmonization. Still, the global result for 2007 was a budget surplus. Unfortunately, the government used that surplus to rush into extraordinary expenditures. You will find all this and much more in the following pages that should give you a better grasp at the state of tax competition in the European Union.