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  The coordinated measures of economic stimuli to alleviate the Great Recession of 2008-2009 stopped it from becoming a depression. However, as a consequence, the public deficit of the developed countries that comprise the Organization for Economic Cooperation and Development (OECD) stood at 8% of gross domestic product (GDP) in 2010. The level of public debt will also exceed 100% of GDP in 2011. These levels are not sustainable and put pressure on long-term interest rates, jeopardizing balanced economic growth.

  Hence the need to withdraw fiscal stimuli and for budget consolidation plans. Even the government of one of the advanced countries that's performing the best, namely Germany, has postponed the reduction in taxes that formed part of the governing coalition's election manifesto for the sake of responsible fiscal policy, in accordance with the new mandate entered into the German constitution.

  However, budget adjustment measures can affect expenditure or revenue (see the Box «Pursuing sustainable and balanced growth: the role of fiscal reforms» on page 23). In general, there's empirical evidence that spending cuts are less harmful to economic growth in the long term than tax hikes,(1) especially if we take into account the level reached after the upward trend throughout the last century. In fact, the stimulus plans of developed countries during the Great Recession focused on boosting public spending. However, this Box will concentrate on discussing taxation alternatives.

  Which countries could raise taxes? In principle, the candidates appear to be those with huge public deficits, particularly if they are being targeted by the financial markets, and whose relative level allows them to do so. This would complement government spending cuts in order to sufficiently reduce the public deficit. However, a number of considerations must be taken into account. Firstly, the fiscal system per se is more than the sum of a series of taxes as there are interactions to be considered. Moreover, when raising a tax rate, we must take its level into account since a hike might encourage fraud and could even lead not to higher revenue but lower. Similarly, the issues of equity and efficiency must also be borne in mind.

  Any tax on capital earnings has to deal with the high mobility of capital, boosted by globalization, and securing significant increases in revenue from this area is not considered to be very feasible, given its great sensitivity to tax rates. However, significant progress has been made recently in tackling this problem, controlling the so-called «tax havens» even further and with the implementation of bilateral or multilateral agreements between countries to exchange tax information.

  Raising revenue by taxing companies is also hindered by the mobility of firms within a globalized environment. Moreover, in order to attract investment, quite a few countries have embarked upon a dynamic of fiscal competition that makes it more complicated to raise tax rates. Nonetheless, supranational organizations prefer to increase revenue not so much by raising tax rates but reducing deductions or tax credits, as some may not be justified in terms of efficiency or may cause distortions. Of course, this does not mean they must be eliminated entirely. For example, tax deductions for R&D might be an attempt to internalize positive externalities; in other words, situations in which social gains exceed the private.

  (1) See IMF, World Economic Outlook, October 2010.

  The employment factor is not considered to be so movable. Nonetheless, too high an increase in personal income tax could harm investment in human capital and consequently economic growth. To raise taxes via this area, experts from the International Monetary Fund particularly recommend revising the expenditures for this tax, which might not always be appropriate. For instance, it's estimated that the main effect of the current mortgage deduction in the United States was that larger houses were bought.

  Social Security contributions also affect employment. It has been argued that a reduction in company contributions to Social Security could increase the demand for employment as it lowers labour costs. This would be more or less feasible depending on each country's contribution level although its effect on Social Security financing would still have to be considered.

  Given this situation, taxes on consumption appear to be the least harmful to economic growth in the medium and long term, according to some economic studies.(2) Among these, the most important tax is value added tax, which could represent quite a significant source of higher revenue, within certain limits, especially for those countries below the average. However, we must not forget that, in the short term, tax hikes would push up consumer price inflation and might increase company costs if passed on to wages.

  Experts from the International Monetary Fund(3) therefore recommend withdrawing some preferential treatments, if these are not sufficiently justified. This, together with more efficient tax administration and greater fulfilment, would help to notably boost public revenue.

  On the other hand, in some cases special taxes might be raised. For example, energy efficiency could be encouraged and the environment protected (see the Box «Pursuing sustainable and balanced growth: the role of fiscal reforms» on page 23), although the impact on competitiveness would also have to be considered. It has also been proposed that a hike in taxation on alcohol or tobacco, as well as increasing revenue, would meet public health targets.

  In any case, as far as the taxable base is concerned, the least mobile area is real estate and some studies(4) claim that taxes on this are less harmful to economic growth than special taxes. However, taxes on real estate are usually decided at a level lower than the state and, moreover, are generally especially unpopular.(5)

  In economics, as in medicine, there are no remedies without a side effect. That's why, depending on each country and the economic stage it's at, a certain «cocktail» of measures might be recommendable, after a cost-benefit analysis. This is ultimately a political decision given that, in short, fiscal structure depends on each society's choice of how to finance the level of public spending it believes to be suitable.

  (2) See Myles, G. D., 2009, «Economic Growth and the Role of Taxation - Theory», OECD Economics Department Working Papers 713. OECD Publishing. Doi: 10.1787/222800633678.

  (3) See IMF, Fiscal Monitor, November 2010.

  (4) See OECD, Tax Policy Reform and Economic Growth, 2010. OECD Publishing. http://dx.doi.org/10.1787/9789264091085-en.

  (5) See European Economy. Occasional Papers 45. March 2009. «The quality of public finances and economic growth: Proceedings to the annual Workshop on public finances». Brussels, 28 November 2008.

  This box was prepared by Pere Miret

  European Unit, Research Department, "la Caixa"

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