Sunday

29th May 2016

Analysis

Europe's attention finally shifts from bailouts to tax cuts

  • Shifting tax from labour to property and consumption is a new priority for EU finance ministers. (Photo: .michael.newman.)

It is a sign that the European economy is no longer in crisis-territory that tax cuts rather than bailouts dominated Monday’s (7 July) meeting of eurozone finance ministers.

Ministers at the monthly Eurogroup meeting agreed to sign off the next €1 billion tranche of Greece’s bailout programme almost as an afterthought. Instead, the main item of discussion focused on how they can cut business costs and increase the pay-packet of the average European.

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In its annual set of economic recommendations to the EU’s 28 countries last month, the European Commission urged 11 euro-area countries to reduce their so-called ‘tax wedge’ - the difference between the wage costs of a worker to their employer and the amount of 'take-home-pay' he or she receives when taxes and social security contributions have been deducted.

At yesterday’s Eurogroup, acting economic affairs commissioner Siim Kallas said that the EU executive’s simulations “indicate that a joint tax shift from labour to consumption by euro area countries could add €65 billion to output and create around 1.4 million jobs over the next decade.”

For its part, the Commission is expected to produce its own assessment on common principles for reducing tax burdens over the summer.

This development should be welcomed but it is not a surprise. The Commission has been recommending that governments cut taxes on work in favour of property and environmental levies for several years.

In autumn 2012, a Commission paper on the bloc’s economic prospects concluded that "the tax burden on labour should be substantially reduced in countries where it is comparatively high and hampers job creation.”

The EU as a whole is known for combining high-tax rates with generous welfare programmes, particularly in northern Europe, but many governments have been slow to realise that such regimes can be paid for without penal levels of income tax.

A study by the conservative New Direction think-tank this spring found that an employer in Belgium spends €2.31 for every €1 its employees receive in take-home pay. And Belgium is hardly the only country to have such a problem.

The New Direction research also found that the average real tax rate faced by European workers will rise marginally from 45.1 percent last year to 45.3 percent in 2014, against an OECD average of around 35 percent.

Several governments have clearly got the message.

In January, the French government stated that it would cut payroll taxes by €30 billion. Two months later, Matteo Renzi’s new Italian government announced income tax cuts worth €10 billion for workers earning less than €25,000 per year. Spain, Ireland and the Netherlands are also planning similar measures.

The IMF believes that shifting its tax burden from labour to consumption could, on its own, be worth more than 0.5 percent of GDP to the Italian economy.

High ‘tax wedges’ are a huge barrier to companies employing people, hardly smart policy in good times but particularly daft when average unemployment across the EU is over 10 percent, and more than double that in the likes of Spain, Italy and Greece.

Making it easier for firms to hire would create the virtuous circle of more employed workers paying more taxes.

They also provide a disincentive for people from working. Low take-home pay also increases the number of workers claiming welfare benefits.

Not that any giveaway will be for free. The Commission has not spent the last five years telling EU governments to cut their deficits only to encourage them to reduce their tax take.

As a result, the communique agreed by ministers talks of tax cuts being financed through “revenue-neutral tax shifts ... away from labour to revenue sources that are less detrimental to growth such as consumption taxes, recurrent property taxes and/or environmental taxes.”

Speaking more broadly, shifting tax bases away from labour would reflect modern economic realities.

Over the past 20 years, the value of property and assets has risen far quicker than incomes across Europe, and the smartest move, particularly in countries where real estate markets are starting to take off again, would be greater use of annual property taxes. It would be fairer, and help dampen property bubbles.

The mark of a progressive tax system is increasingly not how governments tax work, but how they tax the new drivers of wealth.

In contrast, a hike in consumption taxes could be just as regressive as penal income tax rates. For example, increasing the VAT on everyday items such as food, utility bills and petrol disproportionately hits people on lower wages.

Tax regimes are notoriously difficult to re-write without upsetting more people than you please, which is the main reason why politicians tend not to touch them unless absolutely necessary.

But when it comes to cutting tax wedges, politicians need to go as fast they can. Businesses and Europeans both in and out of work will thank them for it.

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