Download Efficient tax policies following Efficient tax policies following Cyprus

Efficient tax policies following
Cyprus economic downturn
November, 2015
12/8/2015
Contents
9
9
9
9
9
9
Introductory remarks
Impact of economic fluctuations on tax revenue
Tax optimization rule under linear income taxation
Efficient tax policy mix for Cyprus fostering growth
Conclusions
References
Introductory remarks
9 Tax adjustments after lasting economic downturn are
necessary to combat rising income gaps and bring the
economy back to steady equilibrium.
equilibrium
9 The safest way to achieve this is to pursue tax optimization
g efficiency
y and social cohesion on an
rules ensuring
individual and social level.
9 The best optimization rule can be formed through optimal
tax rates combining efficiency with social cohesion so as
(dis)incentives on labour and capital remain consistent.
9 The abovementioned
abo ementioned lead to the efficiency–equity
efficienc eq it trade off
highly associated with the informal economy and the
existence of tax evasion of which Cyprus
yp
suffers.
Impact of economic fluctuations on tax revenue
Impact of economic fluctuations on tax revenue
Figure 1: Indirect and direct taxation revenue % change, 2005‐2014
20
20
10
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
0
10
‐10
ind
direct taxation %
direct taxation %
10
‐10
‐20
‐30
‐20
direct taxation % change
11/9/2015
indirect taxation % change
4
I
Impact
t off economic
i fluctuations
fl t ti
on tax
t revenue
9
9
9
9
9
Factually, lower economic activity leads to reduction of tax revenues
Factually
through reduced indirect and direct tax revenue collections.
In figure 1, for 2011-2014, it is shown that direct taxation revenues
follow the income path whereas the indirect taxation revenues follow
the consumption path.
It seems that tax revenues are highly correlated with the business
y
with some time lag
g as depicted
p
in figure
g
2.
cycle
For years prior to 2007, Cyprus has been enjoying high tax
revenues associated with even higher growth rates due to some
exogenous factors such as the tax reform of 2002/2003 and the tax
amnesty
t law
l
off 2007 that
th t gave strong
t
i
incentives
ti
t investors
to
i
t
and
d
depositors to repatriate their funds back to the economy.
Tax revenues were also affected by an overheating economy fuelled
by a rapid credit expansion,
expansion lower interest rates and a resulting
housing bubble.
11/9/2015
5
Impact
p
of economic fluctuations on tax revenue
12,0
30,0
8,0
20,0
4,0
10,0
0,0
0,0
2005 2006
2007
2008
2009
2010
2011
2012
2013
2014
‐4,0
‐10,0
‐8,0
‐20,0
GDP in market prices
11/9/2015
Tax revenue %
GDP in market pricees %
Figure 2: Tax revenue & GDP growth
% Tax revenue
6
Impact
p
of economic fluctuations on tax revenue
9
9
9
9
The correlation
Th
l ti for
f Cyprus
C
b t
between
GDP growth
th and
d tax
t revenue seems to
t
be high enough explaining the closed correlation between GDP growth-tax
revenue-fiscal deficit.
The determination coefficient (R²) of GDP is relatively significant at 0.7583.
The correlation coefficient is positive at 0.8 meaning that tax revenues are
statistically significant with GDP growth.
Thus, during booms (slumps) tax revenues increase (decrease) depending
on the economic activity path.
11/9/2015
TAX
GDP
TAX
1
0.8
GDP
0.8
1
7
Tax optimization rule under linear income taxation
9
9
9
9
An important issue for effective tax collection is the issue
of tax evasion, which is a drawback in Mediterranean
Eurozone economies.
If part of tax revenue is lost due to tax evasion, then the
income transfer is reduced and redistributive targets may
not be met causing suboptimal effects on social policy
targets (R. Canbur, et al, 2015).
As a result, the tax evasion effect increases the cost of
raising taxes offsetting an important fiscal policy tool.
Moreover, informal economy could maintain and even
e tend inequality,
extend
ineq alit if not properly
properl addressed leading to
challenging social cohesion conditions.
11/9/2015
8
Tax optimization rule under linear income taxation
9
9
On income tax, if normative reasons lead to progressive
taxation, it then depends upon the scale of progressivity
to achieve more equal income distribution without at the
same time deteriorating economic efficiency.
efficiency
On commodity taxation, what matters to achieve tax
optimization is the tax effects on substitute goods
causing higher indirect taxation on price inelastic
commodities to minimize the substitution effect (P. Pashardes,
2003).
2003)
9
The efficiency of the tax system could lead to more
favorable effects on tax revenue, better public goods
provision and ultimately, faster poverty reduction and
embedded robust social cohesion.
11/9/2015
9
T optimization
Tax
ti i ti rule
l under
d lilinear iincome ttaxation
ti
9
9
9
9
9
The upswing of fiscal deficit following the downturn
unavoidably is leading to reduced outlays inter alia in social
expenditure as depicted in figure 3.
Th reduction
The
d ti
i social
in
i l expenditure
dit
f ll
follows
th increase
the
i
off
fiscal deficit.
From literature, it seems that a flat tax, with a universal lumpsum transfer,
t
f
could
ld be
b close
l
t the
to
th optimal
ti l rule
l and
d optimal
ti l
taxes should depend on personal characteristics, as well as,
income.
M i t i i
Maintaining
fi
fiscal
l deficit
d fi it on a downward
d
d path
th presupposes
that social expenditure follows a reasonable downward path
too.
Th correlation
The
l ti
coefficient
ffi i t off fiscal
fi
l balance
b l
with
ith social
i l
expenditure is estimated at 0.313 exhibiting the correlation of
the two.
11/9/2015
10
Tax optimization rule under linear income taxation
Figure 3: Fiscal deficit /GDP & social expenditure % 2008‐2014
fiscal deficit/GDP, %
social expenditure
4
16
3,2
12,4
2
12 1
12,1
12
10,7
8
0
2008
2009
2010
55
5,5
2011
2012
2013
‐0,2
,
2014
4
2,6
‐2
0
‐4
‐3,8
‐4,8
‐6
11/9/2015
‐5,6
‐4,8
‐4
‐4,9
‐5,8
58
‐5,1
‐8
11
Efficient tax policy mix fostering
growth & social cohesion
9
9
9
Tax evasion
T
i distorts
di t t the
th tax
t collection
ll ti system
t
i
increasing
i
economic inefficiency, raising the fiscal deficit and
lowering
gp
prospects
p
of p
poverty
y reduction.
The relationship between the fiscal deficit to GDP with
poverty or social exclusion explaining that higher fiscal
d fi it reduces
deficit
d
relative
l ti
poverty
t due
d
t lower
to
l
social
i l
expenditure, and vice versa.
It was estimated that the correlation coefficient between
the fiscal balance and poverty equals -0.26 meaning that
expansionary fiscal policy could lower poverty or social
exclusion
l i
th
through
h possibly
ibl higher
hi h
social
i l protection
t ti
expenditure improving social cohesion conditions.
11/9/2015
12
Conclusions
9
9
9
9
9
Tax policy can reverse some of the negative economic impact
following a significant economic downturn similar to the one that
Cyprus experienced recently.
After Cyprus experienced a downswing in economic activity,
activity tax
containment on business activity and employment could enhance
labour growth amid economic upturn and facilitate faster and robust
recovery.
Policy measures to ease tax burden on labour could also mitigate
overall taxation on employment and expand labour demand
necessary for a sustainably sound growth.
E t d the
Extend
th network
t
k off tax
t
t ti
treaties
f the
for
th avoidance
id
off double
d bl
taxation with countries that Cyprus maintains significant financial
and trade relations.
Policies to combat tax evasion could also reduce poverty once more
public revenue could finance social protection expenditure to
alleviate poverty.
11/9/2015
13
Indicative References
1.
2.
1.
2.
3.
4.
5.
Ministry
Mi
i
off Fi
Finance website
b i www.mof.gov.cy
f
Statistical Service website www.cystat.mof.gov.cy
A. Atkinson & J. Stiglitz “Public Economics”, 1980.
B. Salanie “Economics of Taxation”, 2011.
Stiglitz “Economic of the Public Sector”, 2015.
P. Pashardes “Advanced microeconomics”, Greek edition, 2003.
R Kanbur,
R.
K b J.
J Pirttila,
Pi ttil M.
M Tuomala,
T
l T.
T Ylinen
Yli
“O ti l taxation
“Optimal
t
ti and
d
public provision for poverty reduction”, CEPR, 2015.
11/9/2015
14