Tax and social policy reform: Some lessons from new EU member states

1. Tax and social policy reform: Some lessons from new EU member states Ben Slay Senior economist UNDP Bureau for Europe and CIS 12 January 2000

2. Presentation topics • Tax reform and: • EU accession • Links to social policy, labour market reform • Initial lessons from 5 new member states that have: • Combined these reforms • Introduced flat taxes • Tentative conclusions: • Reforms have been successful • Useful experience for Turkey?

3. GDP in the EU NMS: How does Turkey compare? 2008 per-capita GDP (in PPS terms, EU average = 100), Eurostat data

4. Which countries? Estonia

5. What’s a flat tax? • Key feature: A single, proportionate tax rate • Other common features: • Fewer exemptions, deductions • Same rate for different taxes (PIT, CIT, VAT . . . ) • Attempt to align de jure tax systems with de facto capacity

6. Are flat taxes “fair”? • “It depends”—differing normative views • Literature says: • “Vertical equity” may be violated . . . • . . . But a high taxable income threshold can protect low-income taxpayers . . . • . . . And better compliance increases de facto progressivity • For a flat tax to work, taxpayers have to believe that rates on “legalised” incomes won’t be raised

7. “Flat tax” countries examined here Source: Business Eastern Europe, 22 January 2008, pp. 1-2.

8. Social policy reform • Restructure social service provision to improve quality, reflect trends in: • Demographics • Labour markets • State budgets • Social protection: • Reduce benefit dependency • End ”poverty traps” • “Make work pay” • Better target social assistance

9. Labour market • Labour code reform, to: • Make redundancies easier, to strengthen employer hiring incentives • Promote “non-standard” employment • Support new “public private partnerships” • “Welfare to work” programmes • Allow private job placement firms to compete with state employment offices • Get links to social, tax policies right • Goal: Reduce high marginal tax rates for low-income workers (“unemployment traps”)

10. Performance criteria for assessing reforms’ impact • Output (GDP) • Labour market: • Employment • Unemployment • Fiscal trends • Poverty and inequality

11. Performance: Good on GDP growth . . . Average annual GDP growth 2005-2008 % points above NMS average

12. . . . And on employment Average annual employment growth 2005-2007 % point difference from NMS average

13. Reforms have not upset fiscal balance . . . General government budget (% of GDP), annual averages for 2002-2007 period. Eurostat data.

14. . . . Or produced large public debts General government debt, % of GDP, 2007

15. Unemployment rates fall, both overall . . . Average annual unemployment rates % deviation from average NMS decline

16. . . . And for youth unemployment Average annual youth unemployment rates % deviation from average NMS decline

17. “Unemployment trap” revisited • Example: Family of four • 2 parents, two children • 1 parent works, earns 33% of average wage • Benefit eligibility: • Unemployment benefits (for other parent) • Child allowance (for children in low-income families) • Supplement for low-income families

18. Question: Do benefits fall as earned income rises?Answer: Yes, a lot Effectivetax rate on additional earned income, in form of lost benefits Q: Why take the work? (Unemployment trap)

19. “Unemployment trap”: Getting weaker? Marginal tax rate on income earned by worker supporting family of 4 at 33% of national wage

20. Absolute poverty rates correlate with GDP 2005 World Bank, UNDP data, based on PPP exchange rates, $4.30/day poverty threshold

21. Relative poverty: Do Ginis point to problems? Gini coefficients, World Bank data

22. Conclusions • Tax reform: Not only about growth • It’s also about poverty reduction, social inclusion • Key questions—Links between taxes and: • Labour, social policy • Joint inclusion memorandum (in accession negotiations) • When “done right”, flat tax reform can: • Reduce poverty • Support social solidarity • Perhaps at the cost of higher inequality