How can public finance reforms boost economic growth and · long-term change in a public finance instrument while keeping overall government spending and revenue constant Note: A

How can public finance reforms

boost economic growth and

enhance income equality?

Laurence Boone

OECD Chief Economist

Lisbon CouncilBrussels, 17 December 2018

• 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.

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

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

PensionsPensions Pensions

FamilyFamily

FamilySubsidiesSubsidies

SubsidiesPublic investment

Public investment Public investment

Other primary expenditure



0

5

10

15

20

25

30

35

40

45

2001 2007 2014

% of potential GDP

Large differences in public finance structure

separate countries

One example: public investment by all government levels


Adjusted for the cycle, 2017

0

2

4

6

8

Per cent of trend GDP OECD average


separate countries

Another example: personal income taxes and social security contributions



0

5

10

15

20

25

30



separate countries

A third example: consumption taxes



0

5

10

15

20

25

30


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.

Size

of

gove

rnm

ent

(cyc

lical

lyad

just

edsp

end

ing

as a

ra

tio

to

po

ten

tial

GD

P, 2

01

6, p

er c

ent)

Index of perceived government effectiveness

Area where greater size means lower GDP

Area where greater size goes with higher GDP

Many public sectors are large with

issues limiting their support

for growth and equality


more supportive of





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

Revenue structure has not dramatically changed,

offering opportunities for reforms


Personal income taxes



Social security contributions



Corporate income taxes



Environmental taxes

Environmental taxes

Environmental taxes

Consumption taxes Consumption taxes Consumption taxes

Property taxes Property taxesProperty taxes

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

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

% C

HA

NG

E IN

INC

OM

E

DECILE OF INCOME DISTRIBUTION

Lower bound Estimate Higher bound

POOREST 10% RICHEST 10%

Note: the bounds delineate 90% confidence intervals.

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 whileincreasing other taxes


-0.5

0

0.5

1

1.5

2

2.5

D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

% C

HA

NG

E IN

INC

OM

E





0

0.5

1

1.5

2

2.5

3

D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

% C

HA

NG

E IN

INC

OM

E




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



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 involvingincreases in inheritance taxes allowing proportionaly cuts in other taxes


-2

-1

0

1

2

3

4

5

6

7

8

D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

% C

HA

NG

E IN

INC

OM

E





A large tax-mix shift is defined as having a 10% probability of being observed over 20 years

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).

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 decadesshow 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

Per

cen

t (2

01

6)

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?

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 data availability (see Annex B). A typical

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 (1.7pp)

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

Many public sectors are large with

issues limiting their support

for growth and equality


more supportive of





Using the proceeds from increases in environmental

taxes to reduce low-income tax wedges benefits all


Per

cen

t

0

5

10

15

20

25

30

35

40

0

5

10

15

20

25

30

35N

ZL

CH

L

KO

R

JPN

DEU

AU

S

GB

R

ISL

NO

R

PR

T

ESP

SWE

GR

C

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

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

Could coupling subsidy cuts with a reduction on the

low-income tax wedge be a pathway for CAP reform?


Per

cen

t

0

5

10

15

20

25

30

35

40

0

10

20

30

40

NZL

CH

EC

HL

CA

NK

OR

IRL

JPN

USA

DEU IS

RA

US

MEX

GB

RD

NK

ISL

LUX

NO

RP

OL

PR

TSV

NES

PSV

KSW

EC

ZEG

RC

NLD FIN

HU

NIT

AA

UT

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 reductionin the all-in tax wedge on low-income earners

• Many OECD countries have very large public sectors thatare seen as not highly effective.

• There is considerable scope for public finance reform tosupport inclusive growth, especially by restructuring the taxmix

• Some revenue-neutral tax reforms boost both growth andequality:

• Reducing the all-in tax wedge on low-income earners

• Relying more on inheritance taxes

• Growth-friendly tax reforms typically increase disposableincomes for all income groups (or at least leave no groupworse off)

• Reform packages, such as coupling environmental tax hikeswith cuts in effective taxes on low-income labour, offer waysto ensure outcomes that are efficient and inclusive.

Selected take-aways

Cournède, B., J.-M. Fournier and P. Hoeller (2018), “Public Finance Structure andInclusive Growth”, OECD Economic Policy Paper, No. 25, OECD Publishing, Paris.

Akgun, O., D. Bartolini and B. Cournède (2017), “The Capacity of Governments toRaise Taxes”, OECD Economics Department Working Papers, No. 1407, OECDPublishing, Paris, http://dx.doi.org/10.1787/6bee2df9-en.

Akgun, O., B. Cournède and J. Fournier (2017), “Effects of the Tax Mix onInequality 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 PublicSpending on Growth and Inequality”, OECD Economics Department WorkingPapers, No. 1344, OECD Publishing, Paris, http://dx.doi.org/10.1787/f99f6b36-en.

Hagemann, R. (2018), “Tax Policies for Inclusive Growth: Prescription VersusPractice,” 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 growthhttp://oe.cd/pfig

http://dx.doi.org/10.1787/6bee2df9-en

http://dx.doi.org/10.1787/c57eaa14-en

http://dx.doi.org/10.1787/15e400d4-en

http://dx.doi.org/10.1787/f99f6b36-en

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How can public finance reforms boost economic growth and · long-term change in a public finance instrument while keeping overall government spending and revenue constant Note: A