Tax and Economic Growth

1. Tax and Economic Growth Chris Heady Economics Department University of Kent GES Summer School University of Kent 13th-15th July 2009

2. Today’s presentation • How the tax system affects growth • Different dimensions of tax policy • Empirical results on the tax mix • Empirical results on income tax design • The tax and growth ranking • Other key policy issues • The trade-off between growth and equity

3. Tax systems and growth

4. Growth or level effects? • It is hard to distinguish between effects of taxes that increase the level of GDP from those that increase the growth of GDP • Even changes that only increase level of GDP have a short- run effect on growth • Tax effects on long-run growth are most likely through productivity (TFP) and investment – endogenous growth theory

5. Tax-to-GDP Ratios

6. Revenue Shares in Selected Countries, 2006

7. Statutory Corporate Tax Rates

8. Overall Statutory Rates on Dividends

9. Decline in Imputation • European countries have reduced shareholder relief, which is not based on corporate taxes paid. • Belgium has introduced an ACE system. • However, US has introduced shareholder relief for both dividends and capital gains. • Small country model implies that imputation does not reduce cost of capital – simply a subsidy for domestic shareholders – but might do for SMEs. • US is a large country, so perhaps shareholder relief is rational for them.

10. Top statutory personal income tax rates on wage income

11. Tax wedge for single individual at average earnings

12. Design Trends in Personal Income Tax • Dual or ‘semi-dual’ income tax systems that tax some or all capital income at lower rates than labour income. • ‘Flat taxes’ – these have typically taxed both capital and labour income at the same rate and have an exemption limit, after which the single rate applies. • ‘Making work pay’ policies that involve in-work tax credits and/or reductions in employer social security contributions for low-paid workers.

13. Standard rates of Value Added Tax and share of total tax revenues

14. VAT Revenue Ratios (VRRs)

15. Revenues from environmentally-related taxes

16. The evolution of property taxes (as a percentage of GDP)

17. The pattern of property taxes as a share of GDP, 2006

18. Aims of the OECD study • Does the tax structure, as opposed to the level of taxes, matter for GDP per capita and its rate of growth? • To what extent do different tax provisions affect investment and productivity (TFP)? • Does the industry/firm structure matter for the impact of taxes?

19. Empirical results: Tax mix Macro findings suggest a “ranking” of taxes in terms of their negative impact on GDP per capita: property taxes (particularly recurrent taxes on residential property) < consumption taxes < personal income taxes (including social security contributions) < corporate income taxes.

20. Personal income taxes • Progressive personal income taxes reduce growth • High top marginal personal income tax rates reduce productivity growth, especially in industries with industries characterised by high entry rates of new firms • High social security contributions reduce productivity growth, especially in labour intensive industries.

21. Corporate taxes: industry level • Corporate taxes reduce investment by increasing the user cost of capital. • Corporate taxes reduce productivity and seem to matter more in highly profitable/risky industries. • R&D tax incentives seem to increase productivityand seem to matter more in R&D intensive industries.

22. Corporate taxes: firm level • Statutory corporate taxes seem to have a smaller negative impact on productivity growth in firms that are both young and small. • Statutory corporate taxes seem to have a stronger negative impact on productivity growth in ‘dynamic’ firms, that are profitable and experiencing rapid productivity growth.

23. The tax and growth ranking 1 • Recurrent taxes on immovable property can offset other tax preferences and improve capital allocation • Taxes on property transactions also offset other tax preferences but discourage reallocation of housing – and labour • Other property taxes can also distort capital allocation and savings

24. The tax and growth ranking 2 • Consumption taxes can affect labour supply but are mainly otherwise neutral, especially VAT • Personal income taxes are more harmful because they are more progressive (marginal tax > average tax) and because they discourage savings

25. The tax and growth ranking 3 • Corporate taxes are most harmful as they discourage investment and productivity improvements. They also reduce foreign direct investment and increase compliance costs. Finally, corporate taxes often have a large number of distortionary tax preferences for particular activities, distorting the allocation of resources

26. Other key policy issues • Broadening the base of consumption taxes is better for growth than increasing the rate. • There is limited scope to improve growth by using multiple consumption tax rates, and their equity effects are best achieved by other means. • In-work tax credits can promote growth by increasing participation rates, but care is needed to contain costs and minimise adverse effects on hours worked.

27. Growth and equity • Move from income to consumption taxes generally seen as regressive • Reducing progressivity, including cuts to top rates of personal income tax, is regressive BUT: • Residential property tax need not be regressive • Corporate income tax may fall on workers

28. CONCLUSIONS • Growth can be increased, at least in the short-to-medium terms, by shifting away from income taxes • Recurrent taxes on immovable property are the least harmful to growth • It is necessary to design individual taxes well in order to benefit most from any tax shift • There is likely to be a trade-off between growth and equity, but there may be exceptions