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

a) It is commonly alleged that redistributive targets can better be reached through the ex-
penditure rather than through the revenue side of the budget (for instance: EU Commission
2002). But can we credit the underlying calculations? Ultimate demonstrations for an already
long time have been given (e.g. Goodin and Le Grand 1987) according to which welfare and
other public services are mostly captured by the middle class. The redistributive impact
should then be due mainly to social protection and particularly to public pensions, thanks to
their predominant amount. However the unavoidable suspicion is that these estimates are sin-
gle generation ones, without considering together the effects of PAYG social contributions,
usually proportional if lower net wages but regressive when passed on prices in non-
competitive markets;

b) in a world and at a time in which inequality of ex ante incomes is rapidly (and worry-
ingly) increasing (Atkinson 1999b), not to weaken the redistributive effects of taxation seems
like a suitable and reasonable policy choice;

c) looking at the results by the most recent theoretical an empirical literature, it turns out
that standard theory arguments against redistributive policies (i.e. their supposed incentive-
reducing effects with respect to growth) do not seem to hold and perhaps need to be re-
versed.²⁴ Be careful of course to not mistake the general taxation-to-growth effect (see back,
par. 2.4.1) for the differential impact of redistributive taxation.²⁵

Vertical equity has also been eroded by the decreased burden on capital incomes due to
fiscal competition. The Nordic “Dual income tax system” has then been viewed as a good
compromise between equity and contrasting capital flights (Cnossen 2002). Really it is so
only under the condition that income and wealth are evenly distributed and highly correlated.
This may be the case in some countries, but not in all. For the first 1990s Wagstaff et al.

²⁴ The conventional OT idea concerning the unavoidable trade-off between equity and efficiency has recently
been heavily challenged by a large number of empirical analyses. A negative correlation repeatedly was founded
between inequality and growth. Still more surprisingly, growth rates seem positively influenced by redistributive
policies, also if performed by increasing tax progressivity. The most convincing theoretical root of these evi-
dences has been found with reference to economies in which wealth and human capital endowments are hetero-
geneous across individuals and capital markets are imperfect. The negative effects of inequality on growth might
thus depend on: a) the reduction of investment opportunities; b) the worsening of borrowers’ incentives; c) more
macro-economic volatility (Aghion and Caroli 1999).

²⁵ The standard competitive analysis of labor markets usually considers labor tax progressivity (i.e. the degree of
substitution effect) conflicting with employment. This result is however generally reversed by unionized markets
analysis (e.g. Pissarides 1998).

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