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Tax and Economic Growth Chris Heady Economics Department University of Kent GES Summer School University of Kent 13th-15th July 2009 www.kent.ac.uk Today’s presentation • • • • • • • How the tax system affects growth Different dimensions of tax policy Empirical results on the tax mix Empirical results on income tax design The tax and growth ranking Other key policy issues The trade-off between growth and equity ‹#› Tax systems and growth Determinants (Drivers of growth) Proximate sources (growth accounting) Quantity Labour Economic growth Capital Multi-factor productivity Markets and institutions; policies Quality Hours worked Skill composition Machine hours Asset composition; embodied technology Efficiency; disembodied technology; organisational innovation Participation decision (E) Working time (H) Investment in human capital (HK) -- Investment in fixed capital (K) -- Investment in innovation (e.g. R&D) -- Exposure to trade FDI -- Allocative efficiency (Alloc) Entrepreneurship (Entr) Corporate taxes Personal income taxes Social security contributions Consumption taxes Taxes on property and wealth Benefit systems Education and training Labour market regulation Product market regulation Barriers to trade and investment Public funding of business R&D & R&D tax subsidies Financial system regulation Others ‹#› Growth or level effects? • It is hard to distinguish between effects of taxes that increase the level of GDP from those that increase the growth of GDP • Even changes that only increase level of GDP have a short- run effect on growth • Tax effects on long-run growth are most likely through productivity (TFP) and investment – endogenous growth theory ‹#› 20 20 20 20 07 06 05 04 03 02 01 00 99 98 97 EU15 average 20 20 20 20 19 19 96 95 94 93 92 91 90 United States 19 19 19 19 19 19 19 89 88 87 86 85 Denmark 19 19 19 19 19 84 83 82 81 80 79 78 77 76 75 Australia 19 19 19 19 19 19 19 19 19 19 19 Tax-to-GDP Ratios 60 OECD average 50 40 30 20 10 0 ‹#› Revenue Shares in Selected Countries, 2006 Personal Income Property Corporate Income General Consumption Social Security Specific Consumption Payroll Other 100% 80% 60% 40% 20% he rla nd ew s Ze al an d N or w ay Po rtu ga l Sp ai n Sw e Sw den itz U er ni la te nd d Ki ng U do ni m te d St O EC at es D av er EU ag 15 e av er ag e N M ex ic o N et pa n Ja Ita ly Au st ra lia C an ad a Fr an ce G er m an y H un ga ry Ire la nd 0% ‹#› Statutory Corporate Tax Rates Top CIT rate 2000 50 Top CIT rate 2008 OECD average in 2000 and 2008 40 30 20 10 JPN US FRA BEL CAN LUX GER AUS NZL SPA MEX NOR SWE UK ITA KOR PRT FIN NLD AUT DNK GRC SWI CZE HUN TUR POL SVK ICL IRL 0 ‹#› Overall Statutory Rates on Dividends Overall top tax rate on dividend income 2000 Overall top tax rate on dividend income 2008 80 70 OECD average in 2000 and 2008 60 50 40 30 20 10 DNK FRA US SWE CAN KOR GER IRL NOR HUN AUS UK JPN NLD LUX BEL AUT ITA SPA SWI PRT FIN NZL POL TUR CZE MEX GRC ICL SVK 0 ‹#› Decline in Imputation • European countries have reduced shareholder relief, which is not based on corporate taxes paid. • Belgium has introduced an ACE system. • However, US has introduced shareholder relief for both dividends and capital gains. • Small country model implies that imputation does not reduce cost of capital – simply a subsidy for domestic shareholders – but might do for SMEs. • US is a large country, so perhaps shareholder relief is rational for them. ‹#› Top statutory personal income tax rates on wage income ‹#› Tax wedge for single individual at average earnings 2000 2007 60 OECD average tax wedge single taxpayer at 100% AW (0 children) in 2007 (reduction of 0.2 pct. point since 2000) 50 40 30 20 10 BEL HUN GER FRA AUT ITA SWE NLD FIN CZE POL TUR GRC DNK SPA SVK LUX NOR PRT UK CAN US SWI JPN ICL AUS IRL NZL KOR MEX 0 ‹#› Design Trends in Personal Income Tax • Dual or ‘semi-dual’ income tax systems that tax some or all capital income at lower rates than labour income. • ‘Flat taxes’ – these have typically taxed both capital and labour income at the same rate and have an exemption limit, after which the single rate applies. • ‘Making work pay’ policies that involve in-work tax credits and/or reductions in employer social security contributions for low-paid workers. ‹#› Standard rates of Value Added Tax and share of total tax revenues VAT revenue as % of total tax revenues (2006) VAT standard rate (2007) 30 OECD average rate (2007) and revenues (2006) 25 20 15 10 5 US DNK NOR SWE ICL FIN POL BEL IRL PRT AUT HUN ITA FRA CZE GER GRC NLD SVK TUR UK SPA LUX MEX NZL AUS KOR SWI CAN JPN 0 ‹#› VAT Revenue Ratios (VRRs) Difference Standard VAT rate (2005) 1976 1980 1984 1988 1992 1996 2000 0.47 0.60 0.51 0.52 0.44 0.60 0.61 0.50 0.60 0.48 0.53 0.58 0.64 0.45 0.70 0.65 0.68 0.31 0.60 1.00 0.67 0.42 0.62 0.46 0.53 0.52 0.78 0.59 0.50 0.57 2003 0.56 0.59 0.47 0.51 0.42 0.60 0.60 0.49 0.55 0.48 0.46 0.53 0.62 0.41 0.68 0.74 0.72 0.32 0.57 1.09 0.56 0.43 0.56 0.54 0.53 0.53 0.75 0.63 0.50 0.57 2005 1996-2005 0.10 0.57 0.02 0.60 0.03 0.50 0.04 0.52 0.15 0.59 0.04 0.62 0.06 0.61 0.00 0.51 -0.06 0.54 0.04 0.46 0.05 0.49 0.08 0.62 0.15 0.68 0.00 0.41 0.00 0.72 0.10 0.71 0.24 0.81 0.07 0.33 0.04 0.61 0.04 1.05 -0.03 0.58 0.07 0.48 -0.10 0.48 0.07 0.53 0.11 0.56 0.05 0.55 0.05 0.76 -0.02 0.53 -0.02 0.49 0.04 0.58 10.0 AUSTRALIA (b) 0.58 0.59 0.61 0.63 0.65 0.65 20.0 AUSTRIA 0.47 0.49 0.53 0.50 0.61 0.57 21.0 BELGIUM 0.48 0.44 7.0 CANADA (c) 0.44 19.0 CZECH REPUBLIC 0.58 0.55 0.60 0.60 0.61 0.64 25.0 DENMARK 0.54 22.0 FINLAND 0.51 0.53 0.61 0.62 0.69 0.64 19.6 FRANCE 0.60 0.62 0.50 0.52 0.57 0.56 16.0 GERMANY 0.42 0.45 0.44 18.0 GREECE 0.43 0.30 25.0 HUNGARY 0.54 0.63 24.5 ICELAND 0.53 0.46 0.43 0.45 0.21 0.30 21.0 IRELAND 0.40 0.39 0.42 0.40 0.43 0.46 20.0 ITALY 0.72 0.70 5.0 JAPAN 0.62 0.66 0.54 0.56 0.53 10.0 KOREA 0.57 0.47 0.57 0.56 0.56 0.60 15.0 LUXEMBOURG 0.26 0.34 0.28 0.30 0.36 15.0 MEXICO 0.57 0.59 0.56 0.51 0.54 0.49 19.0 NETHERLANDS 1.00 0.98 0.91 12.5 NEW ZEALAND 0.60 0.52 0.69 0.63 0.66 0.66 25.0 NORWAY 0.41 22.0 POLAND 0.57 0.51 0.44 19.0 PORTUGAL 19.0 SLOVAK REPUBLIC (d) 0.45 0.57 0.59 16.0 SPAIN 0.50 0.40 0.42 0.38 0.41 0.45 25.0 SWEDEN 0.70 7.6 SWITZERLAND 0.55 0.56 0.59 18.0 TURKEY 0.50 0.49 0.54 0.50 0.46 0.47 17.5 UNITED KINGDOM 0.54 0.53 0.54 0.51 0.52 0.54 17.7 Unweighted average Source: OECD (2008c) (a) VAT Revenue Ratio = (VAT revenue)/([consumption - VAT revenue] x Standard VAT rate) (b) For Australia the differencial VRR is calculated on the period 2000-2005 since GST was introduced in 2000 (c) Calculation for Canada is for federal VAT only (d) For Slovak Republic, the differential VRR is calculated on the period 2000 - 2005 since data is not available for 1996 ‹#› US UK TUR SWI SWE SPA SVK PRT POL NOR NZL 2000 NLD MEX LUX 1995 KOR JPN ITA IRL ICL HUN GRC GER FRA FIN DNK CZE CAN BEL AUT AUS Per cent of GDP Revenues from environmentally-related taxes 2005 6 5 4 3 2 1 0 ‹#› The evolution of property taxes (as a percentage of GDP) 2.0% 1.8% 1.6% Taxes on f inancial and capital transactions 1.4% 1.2% Estate, inheritance and gif t taxes 1.0% Recurrent taxes on net wealth 0.8% 0.6% Recurrent taxes on immovable property 0.4% 0.2% 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 0.0% ‹#› Au st ra l Au ia st Be ria lg iu C ze Ca m ch na R da ep u D blic en m a Fi rk nl an Fr d a G nce er m an G y re e H ce un ga Ic r y el an Ire d la nd Ita ly Ja pa n Lu Ko xe re m a bo ur M g N et exic h N erla o ew n Ze ds al an N d or w a Po y l an Sl ov Po d ak rtu R gal ep ub lic Sp a Sw in Sw ed itz en er la U nd ni T te u r d K ke U ing y ni te do EU d S m ta 1 O 5 a tes EC ve D rag av e er ag e The pattern of property taxes as a share of GDP, 2006 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 Immovable Transactions Other ‹#› Aims of the OECD study • Does the tax structure, as opposed to the level of taxes, matter for GDP per capita and its rate of growth? • To what extent do different tax provisions affect investment and productivity (TFP)? • Does the industry/firm structure matter for the impact of taxes? ‹#› Empirical results: Tax mix Macro findings suggest a “ranking” of taxes in terms of their negative impact on GDP per capita: property taxes (particularly recurrent taxes on residential property) < consumption taxes < personal income taxes (including social security contributions) < corporate income taxes. ‹#› Personal income taxes • Progressive personal income taxes reduce growth • High top marginal personal income tax rates reduce productivity growth, especially in industries with industries characterised by high entry rates of new firms • High social security contributions reduce productivity growth, especially in labour intensive industries. ‹#› Corporate taxes: industry level • Corporate taxes reduce investment by increasing the user cost of capital. • Corporate taxes reduce productivity and seem to matter more in highly profitable/risky industries. • R&D tax incentives seem to increase productivity and seem to matter more in R&D intensive industries. ‹#› Corporate taxes: firm level • Statutory corporate taxes seem to have a smaller negative impact on productivity growth in firms that are both young and small. • Statutory corporate taxes seem to have a stronger negative impact on productivity growth in ‘dynamic’ firms, that are profitable and experiencing rapid productivity growth. ‹#› The tax and growth ranking 1 • Recurrent taxes on immovable property can offset other tax preferences and improve capital allocation • Taxes on property transactions also offset other tax preferences but discourage reallocation of housing – and labour • Other property taxes can also distort capital allocation and savings ‹#› The tax and growth ranking 2 • Consumption taxes can affect labour supply but are mainly otherwise neutral, especially VAT • Personal income taxes are more harmful because they are more progressive (marginal tax > average tax) and because they discourage savings ‹#› The tax and growth ranking 3 • Corporate taxes are most harmful as they discourage investment and productivity improvements. They also reduce foreign direct investment and increase compliance costs. Finally, corporate taxes often have a large number of distortionary tax preferences for particular activities, distorting the allocation of resources ‹#› Other key policy issues • Broadening the base of consumption taxes is better for growth than increasing the rate. • There is limited scope to improve growth by using multiple consumption tax rates, and their equity effects are best achieved by other means. • In-work tax credits can promote growth by increasing participation rates, but care is needed to contain costs and minimise adverse effects on hours worked. ‹#› Growth and equity • Move from income to consumption taxes generally seen as regressive • Reducing progressivity, including cuts to top rates of personal income tax, is regressive BUT: • Residential property tax need not be regressive • Corporate income tax may fall on workers ‹#› CONCLUSIONS • Growth can be increased, at least in the short-to-medium terms, by shifting away from income taxes • Recurrent taxes on immovable property are the least harmful to growth • It is necessary to design individual taxes well in order to benefit most from any tax shift • There is likely to be a trade-off between growth and equity, but there may be exceptions ‹#›