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How can public finance reforms boost economic growth and enhance income equality Laurence Boone Lisbon Council Brussels 17 December 2018

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How can public finance reforms boost economic growth and enhance income equality Laurence Boone Lisbon Council Brussels 17 December 2018

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How can public finance reforms boost economic growth and enhance income equality Laurence Boone Lisbon Council Brussels 17 December 2018

  1. 1. How can public finance reforms boost economic growth and enhance income equality? Laurence Boone OECD Chief Economist Lisbon Council Brussels, 17 December 2018
  2. 2. • Government size weighs on output except where the public deems government to be very effective. • Reforming government spending or the revenue structure without changing its size offers potential to boost output and: Evaluating the impact of public finance structure: Main lessons • Ease effective marginal tax rates on low-income earners • Hike inheritance taxes Reduce disposable income disparities • Increase public investment • Raise recurring property taxes • Lower effective corporate income tax rates Leave disposable income disparities broadly unchanged and improve absolute income levels for all • Reduce subsidies, • Lower wealth taxes • Lighten the tax burden on above-average labour earnings Widen income disparities, but leave no group worse off in terms of absolute income • Even when reallocating the tax burden from more to less distortive taxes, there are limits to increasing tax rates.
  3. 3. Public finance reforms for inclusive growth: Outline of the presentation Many public sectors are large but not necessarily efficient There are ways to make governments more supportive of growth or equity or both Packages can improve the political economy of public finance reforms
  4. 4. Public spending has expanded under considerable pressure from health and pensions Source: OECD Public Finance Dataset (Bloch et al., 2016), 2018 update. Expenditure excluding interest (i.e. primary) and adjusted for the cycle Education Education Education Health Health Health Pensions Pensions Pensions Family Family FamilySubsidies Subsidies Subsidies Public investment Public investment Public investment Other primary expenditure Other primary expenditure Other primary expenditure 0 5 10 15 20 25 30 35 40 45 2001 2007 2014 % of potential GDP
  5. 5. Large differences in public finance structure separate countries One example: public investment by all government levels Source: OECD Public Finance Dataset (Bloch et al., 2016), 2018 update. Adjusted for the cycle, 2017 0 2 4 6 8 Per cent of trend GDP OECD average
  6. 6. Large differences in public finance structure separate countries Another example: personal income taxes and social security contributions Source: OECD Public Finance Dataset (Bloch et al., 2016), 2018 update. Adjusted for the cycle, 2016 0 5 10 15 20 25 30 Per cent of trend GDP OECD average
  7. 7. Large differences in public finance structure separate countries A third example: consumption taxes Source: OECD Public Finance Dataset (Bloch et al., 2016), 2018 update. Adjusted for the cycle, 2014 0 5 10 15 20 25 30 Per cent of trend GDP OECD average
  8. 8. The largest governments are not always the most effective ones Source: Fournier and Johansson (2016) and 2018 update of Bloch et al.’s (2016) database. Sizeofgovernment(cyclicallyadjustedspendingasa ratiotopotentialGDP,2016,percent) Index of perceived government effectiveness Area where greater size means lower GDP Area where greater size goes with higher GDP
  9. 9. Many public sectors are large with issues limiting their support for growth and equality There are ways to make governments more supportive of growth or equity or both Packages can improve the political economy of public finance reforms
  10. 10. Estimated long-term effects of policy reforms on • Output per capita • Household disposable income by decile allowing to gauge • Moves relative to other deciles • Changes in absolute income levels by decile Used econometric regressions • Production function framework for output • Estimation by decile • Long-term effects (after cyclical impacts have played out) Assembled an internationally comparable dataset • Covers 35 countries over 1985-2014 • Adjusts for cyclical effects These public finance differences across countries and changes over time have implications
  11. 11. Revenue structure has not dramatically changed, offering opportunities for reforms Source: OECD Public Finance Dataset (Bloch et al., 2016), 2018 update. Personal income taxes Personal income taxes Personal income taxes Social security contributions Social security contributions Social security contributions Corporate income taxes Corporate income taxes Corporate income taxes Environmental taxes Environmental taxes Environmental taxes Consumption taxes Consumption taxes Consumption taxes Property taxes Property taxes Property taxes Other primary revenue Other primary revenue Other primary revenue 0 5 10 15 20 25 30 35 40 45 2001 2007 2014 % of potential GDP Primary receipts adjusted for the cycle
  12. 12. Reducing net wealth taxes predominantly benefits the rich but raises nearly everybody’s income Estimated long-term change in disposable income after permanently reducing net wealth tax receipts by 0.1% of GDP while increasing other taxes Source: Cournède, Fournier and Hoeller (2018). -0.5 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 %CHANGEININCOME DECILE OF INCOME DISTRIBUTION Lower bound Estimate Higher bound POOREST 10% RICHEST 10% Note: the bounds delineate 90% confidence intervals.
  13. 13. Easing the tax burden on above-average earners improves incomes for all but by more for them Estimated long-term change in disposable income after a 1 percentage point cut in the labour tax wedge applicable to people earning 167% of the average wage while increasing other taxes Source: Cournède, Fournier and Hoeller (2018). -0.5 0 0.5 1 1.5 2 2.5 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 %CHANGEININCOME DECILE OF INCOME DISTRIBUTION Lower bound Estimate Higher bound POOREST 10% RICHEST 10% Note: the bounds delineate 90% confidence intervals.
  14. 14. 0 0.5 1 1.5 2 2.5 3 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 %CHANGEININCOME DECILE OF INCOME DISTRIBUTION Lower bound Estimate Higher bound POOREST 10% RICHEST 10% Moving the tax burden away from low-wage earners improves incomes for all Estimated long-term effect on disposable income of reducing the labour tax wedge applicable at 67% of average income by one percentage point while increasing other taxes proportionally to compensate the revenue loss Source: Cournède, Fournier and Hoeller (2018). Note: the bounds delineate 90% confidence intervals.
  15. 15. Shifting the tax mix towards inheritance taxes boosts output and results in narrower income gaps Estimated long-term effect on disposable income of a large tax-mix shift involving increases in inheritance taxes allowing proportionaly cuts in other taxes Source: Cournède, Fournier and Hoeller (2018). -2 -1 0 1 2 3 4 5 6 7 8 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 %CHANGEININCOME DECILE OF INCOME DISTRIBUTION Lower bound Estimate Higher bound POOREST 10% RICHEST 10% Note: the bounds delineate 90% confidence intervals. A large tax-mix shift is defined as having a 10% probability of being observed over 20 years
  16. 16. Some tax shifts can boost growth with no significant effects on disposable income inequality 0 2 4 6 Lowering the CIT effective rate Raising recurrent property taxes Per cent of output per capita Estimated permanent effect on output per capita of a typically observed long- term change in a tax instrument while keeping overall revenue constant Note: A typically observed long-term change in a public finance instrument is defined as the average across countries of the within-country standard deviation in the tax or spending instrument over time. The brackets show 10% confidence intervals. Source: Cournède, Fournier and Hoeller (2018).
  17. 17. Many countries have limited room to hike VAT rates as a way of funding cuts in more distortive taxes 0 10 20 30 40 50 60 VAT standard rate VAT revenue maximizing rate 95% Conf. Interval Source: Akgun, Bartolini and Cournède (2017). Panel data econometrics of OECD country experiences over the past three decades show that the revenue generated by VAT plateaus when the rate reaches a ‘revenue- maximising’ point, which depends on country characteristics such as openness and expenditure on tax collection Percent(2016)
  18. 18.  Annual taxes on immovable property, not on property transactions  Taxes on consumption, favouring base broadening to rate hikes where rates are already high  Taxes on environmental pollution, but as part of a package, as they can exacerbate inequality Which taxes can be raised to make room for cuts in the more harmful taxes?
  19. 19. Changes of the size already observed in practice have meaningful effects Permanent percentage effect on output per capita of a typically observed long-term change in a public finance instrument while keeping overall government spending and revenue constant Note: A typically observed long-term change in a public finance instrument is defined as the average across countries of the within-country standard deviation in the tax or spending instrument over time. The brackets show 10% confidence intervals. Source: Cournède, Fournier and Hoeller (2018). The bars show the point estimates while bracketed solid lines depict the 10% confidence intervals. Estimates come from panel regressions covering 34 OECD countries over 1981-2014 or fewer observations depending on da 0 2 4 6 Easing the labour tax wedge on low earnings (1.7 pp) Increasing inheritance taxes (0.06 pp of GDP) Lowering the CIT effective rate (4.4 pp) Easing the tax burden on above-average labour earnings (1.7 pp) Lowering wealth taxes (0.1 pp of GDP) Raising recurrent property taxes (0.2 pp of GDP) inequality-widening inequality-narrowing no identified effect on inequality
  20. 20. Many public sectors are large with issues limiting their support for growth and equality There are ways to make governments more supportive of growth or equity or both Packages can improve the political economy of public finance reforms
  21. 21. Using the proceeds from increases in environmental taxes to reduce low-income tax wedges benefits all Source: Cournède, Fournier and Hoeller (2018). Percent 0 5 10 15 20 25 30 35 40 0 5 10 15 20 25 30 35 NZL CHL KOR JPN DEU AUS GBR ISL NOR PRT ESP SWE GRC FIN ITA FRA Bottom quintile Middle quintile Top quintile Long-term change in disposable income following a ½ per cent of GDP increase in environmental taxes accompanied by a same-sized reduction in the all-in tax wedge on low-income
  22. 22. Shifting the tax burden from low income earners to pollution works through two channels  Direct channel: the tax break for low income earners immediately neutralise possible adverse distributional effects from increases in environmental taxes.  Indirect channel: the reduced low-income labour tax wedge in the long term boosts output per capita, with favourable consequences for disposable income across the distribution. A concrete example: British Columbia’s 2008 carbon tax • CAD10 per tonne of CO2 rising to CAD30 per tonne in 2012 on all fossil fuels → including but not limited to motor fuels • 5 percentage point rate reduction for the first two personal income tax brackets • Low-income tax credit • 2 percentage point cut in the provincial rate of corporate income tax
  23. 23. Could coupling subsidy cuts with a reduction on the low-income tax wedge be a pathway for CAP reform? Source: Cournède, Fournier and Hoeller (2018). Percent 0 5 10 15 20 25 30 35 40 0 10 20 30 40 NZL CHE CHL CAN KOR IRL JPN USA DEU ISR AUS MEX GBR DNK ISL LUX NOR POL PRT SVN ESP SVK SWE CZE GRC NLD FIN HUN ITA AUT FRA BEL Bottom quantile Middle quintile Top quintile Long-term change in disposable income following a ½ per cent of GDP cut in subsidies accompanied by a same-sized reduction in the all-in tax wedge on low-income earners
  24. 24. • Many OECD countries have very large public sectors that are seen as not highly effective. • There is considerable scope for public finance reform to support inclusive growth, especially by restructuring the tax mix • Some revenue-neutral tax reforms boost both growth and equality: • Reducing the all-in tax wedge on low-income earners • Relying more on inheritance taxes • Growth-friendly tax reforms typically increase disposable incomes for all income groups (or at least leave no group worse off) • Reform packages, such as coupling environmental tax hikes with cuts in effective taxes on low-income labour, offer ways to ensure outcomes that are efficient and inclusive. Selected take-aways
  25. 25.  Cournède, B., J.-M. Fournier and P. Hoeller (2018), “Public Finance Structure and Inclusive Growth”, OECD Economic Policy Paper, No. 25, OECD Publishing, Paris.  Akgun, O., D. Bartolini and B. Cournède (2017), “The Capacity of Governments to Raise Taxes”, OECD Economics Department Working Papers, No. 1407, OECD Publishing, Paris, http://dx.doi.org/10.1787/6bee2df9-en.  Akgun, O., B. Cournède and J. Fournier (2017), “Effects of the Tax Mix on Inequality and Growth”, OECD Economics Department Working Papers, No. 1447, OECD Publishing, Paris, http://dx.doi.org/10.1787/c57eaa14-en.  Fournier, J. (2016), “The Positive Effect of Public Investment on Potential Growth”, OECD Economics Department Working Papers, No. 1347, OECD Publishing, Paris, http://dx.doi.org/10.1787/15e400d4-en.  Fournier, J. and Å. Johansson (2016), “The Effect of the Size and the Mix of Public Spending on Growth and Inequality”, OECD Economics Department Working Papers, No. 1344, OECD Publishing, Paris, http://dx.doi.org/10.1787/f99f6b36-en.  Hagemann, R. (2018), “Tax Policies for Inclusive Growth: Prescription Versus Practice,” OECD Economic Policy Paper, No. 24, OECD Publishing, Paris. These reports provide additional results and more detail on the analysis Look up the dedicated website on public finance and inclusive growth http://oe.cd/pfig

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