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Reform taxation policy. Direct taxes create distortionsLabour taxes distort labour demand and labour supply decisionsHigh unemployment in EU linked to high labour taxation ?Switch to indirect taxes less distortionary?. Shift tax burden towards indirect taxation: the political dimension. Lisbon st
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1. Shifting the burden of taxation from labour taxes to indirect taxes Werner Roeger
Jan in ’t Veld
European Commission, DG ECFIN
2. Reform taxation policy Direct taxes create distortions
Labour taxes distort labour demand and labour supply decisions
High unemployment in EU linked to high labour taxation ?
Switch to indirect taxes less distortionary?
3. Shift tax burden towards indirecttaxation: the political dimension Lisbon strategy (reduction tax burden low-wage earners)
Verhofstadt’s ‘European pentathlon’
Proposal to shift tax burden in EU to indirect
taxation (target 40 -> 50% % of total taxation)
‘Social’ VAT (FR)
4. Shift tax burden from labour taxes to indirect taxes Consumption tax can be regarded as a more general income tax
(paid by working population and
non-working population)
Less distortionary regarding
labour demand and supply decisions
5. Shift tax burden from direct to indirect taxation Reforms might imply long term gains,
but if adjustment takes time, reforms may have short term losses
Reforms affect distribution of income
(progressivity of personal income tax systems)
Does the reform have losers? (do they get compensated ?)
6. Total tax burden (as % of GDP)
7. Share of indirect taxes in total taxation
8. Indirect taxes /Total taxation
9. Indirect taxes /Total taxation
10. Tax reform simulated with QUEST model: Shift the burden of taxation from labour tax to VAT such that share of indirect taxation in total taxation is 40% in each of the member states
Reform is budgetary neutral (ex ante):
Government expenditure constant
Increase VAT = Reduction Wage tax
11. European Commission’s QUEST model : Derived from dynamic optimisation of utility and profits by economic agents, s.t. intertemporal budget constraints
Long run: neo-classical growth model, but
imperfect competition: mark-ups
involuntary unemployment
Short run dynamics: Keynesian features, but with theoretical foundations
adjustment costs
overlapping contracts
12. Country Coverage Structural models :
Each of the EU member states
US
Japan
Trade feedback models:
11 other countries/regional blocks
13. Consumption rule based on intertemporal utility maximisation households Two types of households: - PIH/Life-Cycle consumers, whose consumption pattern is based on life-cycle income (H) and financial wealth (F)- Liquidity-constrained households (“rule-of- thumb”) who base their consumption decision on disposable income (Ydis)? share of liquidity-constrained consumption
14. Investment: Neo-classical model of investmentInvestment rule derived from profit optimisation problem s.t. adjustment costs
15. Labour market Wage-setting: Bargaining framework (Pissarides)
If there is a successful job match, workers and firms both benefit relative to the alternative state of :
being unemployed and only receiving “reservation wage” (workers)
having an unfilled vacancy (firms)
16. => Wage costs depend on three factors: - the reservation wage Bt (unemployment benefits, leisure ) - labour productivity Yt / Lt - labour market tightness (probability unemployed, vacancy costs) µ bargaining strength workers
17. µ bargaining strength workers: - µ =0 competitive labour market, no bargaining strength of workers- µ =1 insider-outsider model, complete bargaining strength workers Staggered wage contracts: Nominal rigidities
18. Scenario 1: B not indexed to PC
19. Scenario 1: B not indexed to PC
20. Distributional effects: after-tax wage income: (1-tl)*W/PC and real benefits: Ben/PC
21. Scenario 2: compensate losers (1)Benefit recipients
22. Scenario 3: compensate losers (2)Benefit and Transfer recipients
23. Sensitivity testing: share of liquidity-constrained consumers
24. Sensitivity testing: share of liquidity-constrained consumers and slower employment dynamics
25. Sensitivity testing: share of liquidity-constrained consumers
26. Higher share of liquidity-constrained consumers and stronger lagged employment demand
27. Scenario 2: B indexed to W/P and PC Scenario 2.2: B constant, indexed to PC
28. Scenario 4: alternative wage setting model Neoclassical model:
Maximisation over consumption and leisure
=> Wage equation:
29. Scenario 4: alternative wage setting model
30. GDP
31. Employment
32. Conclusions: Tax shift to VAT yields positive employment and output effects (more general income tax)
Size of effects depends on wages and incomes policies
Shifting taxation away from wage earners towards other tax payers ?
unemployment benefits,
social transfers (pensions),
profit and interest income
33. Conclusions (2): This specific reform raises share indirect taxes to 40%
Spillovers : positive demand effect
But : appreciation euro, and interest rate effect depends on monetary policy assumption
Are larger VAT differentials sustainable? (cross-border shopping)
Alternative reform: set a similar high VAT rate in all EU countries (difference in tax shares reflected in differences in direct tax rates)
34. Further extensions Test robustness of results to alternative assumptions
Compensation to profit and interest income earners
Evaluate effects of tax shift in estimated DSGE model with neoclassical labour supply