Tax systems and tax reforms in Europe: Rationale and open issue for more radical reforms



These two latter may produce an higher yield of about two-to-three points of GDP.19 Thus an
increase in consumption taxes of the size of three-to-four points of GDP should be required at
the end. It must come from VAT and not excise duties which have well more narrow bases
and higher rates. Further notice that inflationary effects have not to be overestimated, the
more consumption taxes substituting social contributions, i.e. an item of cost of labor at least
in part passed on prices.
20

The main open question is instead if is it really effective to reduce tax burden on labor by
increasing consumption taxes. The topic is controversial and highly debated in multi-faceted
literature. Hereafter we report just three main points which together lead to the (tentative)
conclusion that more consumption taxes may allow to alleviate those which burden on labor,
the two being not perfect substitutes.

(i) Theory - The traditional textbook equivalence of taxation on labor income and con-
sumption obviously still has some good arguments (e.g. Cnossen 2002), but it is increasingly
open to question, due to its lacking empirical frame (Carone and Salomaki 2001).
21 Further,
the old proposition that heavier taxes on consumption may increase savings and investments
still holds. Finally two central OT arguments should be reminded: first, consumption taxes do
not change the inter-temporal consumption allocation and therefore its growth rate (Milesi-
Ferretti and Roubini 1998); second, efficiency losses would be reduced if taxation is shifted at
a lesser rate to a wider basis.

(ii) Econometric estimates - The last and more robust estimate has been performed by us-
ing the EU Commission’s Quest II model. As to its main result, GDP one per cent shift from
corporate to consumption tax would move GDP by 1.6 points and wages by 2.1 points from

19 They could arrive from an increase of present European average to the level of the countries more taxing im-
movable property (United Kingdom, 3.5 per cent) and environment externalities (The Netherlands, 1.7 per cent)
(Eurostat data).

20 In 2000 private consumption in the Euro area amounted to 3674 billions euro at current price and to 3383 bil-
lions euro at constant (1995) prices (ECB Bulletin, 1 2003). Consequently consumption deflator was 1.086. It
rises to 1.10 if charged by 0.7 GDP points of VAT increase, by assuming a five years planning period. The ap-
parent large inflationary impulse of 1.3 points decreases to a half if one assumes that socials contributions are al-
ready embodied in labor cost by at least 50 per cent and decreases further to something more than 0.4 points, by
limiting VAT shifting to 75 per cent. Consider further that both the hypotheses adopted in the previous calcula-
tions are rather conservative.

21 EU taxes on consumption have a basis one third higher than labor income taxes. Tax basis for capital is half
than that for labor.

13



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