- There are ways for governments to reform public finance structures to boost economic growth and enhance income equality through packages like increasing public investment, inheritance taxes, and property taxes while lowering taxes on low-income earners and corporate income taxes. - Estimates show some reforms like reducing taxes on low wages can increase incomes for all income groups while shifting taxes from low to high income earners widens disparities. - Pairing environmental tax hikes with cuts to taxes on low incomes benefits all income groups by boosting overall output.

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. • 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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.  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. 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. 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. 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. 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. 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. • 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.  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