RICERCA ITALIANA     

Globalisation, demographic trends and the future of fiscal systems

Università Commerciale "Luigi Bocconi" - Milano

Abstract

The aim of the research project is to analyze the evolution of tax and welfare systems in an international perspective and to study the effects of globalization and of demographic changes on national tax systems. The analysis will be both theoretical and empirical.

Although these issues have been widely debated on theoretical grounds, a broad consensus on the impact of such phenomena is still missing. From an empirical point of view, it remains to be shown what the effects are of alternative reforms that allow the fiscal systems to react to the new needs imposed by the change of the structure of the economy.

The interest for the analysis of interdependencies among national fiscal policies increased along with the augmented opening of the markets of goods and inputs. It is common opinion that "fiscal competition" is one of the more relevant factors of change of modern systems. It is often stated that to attract mobile tax bases and to avoid jeopardizing the competitiveness of national products it is necessary to reduce the tax burden, to decrease the progressivity of taxation and to introduce a larger co-ordination of fiscal policies at the international level. Although the economic literature has widely evolved during the last decade, it seems unable to explain the fiscal policies of governments in highly integrated economies.

Moreover, the ongoing demographic trend has put the traditional welfare system under pressure: additional resources are needed as well as a revision of the private-public composition of welfare services, with consequences on the ways they are financed. The privatisation policies and the decline of investments in infrastructure have induced a complete revision of public services financing, with more importance given to price mechanisms rather than to taxation.

The present research project aims to provide an answer to the following questions:
1. What is the effect of globalization on the structure of the fiscal systems, with particular reference to the level of tax burden, its composition and the degree of tax redistribution? The analysis is mainly theoretical and puts together two recent streams of economic literature, enlarging and partly modifying the conclusions of the traditional theory of tax competition.
2. How do the changes of welfare systems induced by the ageing of the population and by globalization affect the structure of fiscal systems? Particular attention will be devoted to the privatisation of pension systems and of family assistance programs and to the increased targeting of job market policies. The theoretical analysis is focussed on the redistributive consequences of increasing the private provision of welfare services, introducing tax rebate incentives. The empirical analysis is focussed on Italy and is aimed to develop a tax-benefit microsimulation model to estimate behavioural responses to a set of alternative reforms. These simulations will be partly based on recent reforms proposed or implemented in other OECD countries.
3. How do the restructuring of the tax systems interact with the policies of privatization, investment in infrastructure and public services? The analysis is aimed to propose a methodology to measure the stock of public capital, to study the link between public investments and restrictive fiscal policies and to investigate the EU policy to support infrastructure investments, with particular reference to new member states.

Finally, the project includes a thorough analysis at the international level of recent reforms of tax systems. This institutional study is first developed at the country level. The main changes in the fiscal systems are then compared with other countries in the same and in different areas of the world economy. The analysis will focus on East Asia and Latin America, not to interrupt the analysis of national fiscal systems funded by PRIN 2002. <<<

Principal Investigator

Roberto ARTONI Università Commerciale "Luigi Bocconi" MILANO

Research Objectives

Since the 1990's the tax systems of the main regions of the world economy faced needs of restructuring and reform. The solutions implemented by national governments have been different even in presence of similar phenomena among different areas, such as the ageing of the population, the stronger economic integration, the demand for reduction of the tax burden, the evolution of the job market.
The aim of the research project is to analyze the evolution of tax and welfare systems in an international perspective and to study the effects of globalization and of demographic changes on national tax systems, both theoretically and empirically.
The interest for the analysis of interdependencies among national fiscal policies increased along with the augmented opening of the markets of goods and inputs. It is common opinion that "fiscal
competition" is one of the more relevant factors of change of modern fiscal systems. In particular, it is often stated that to attract mobile tax bases and to avoid jeopardizing the competitiveness of national products it is necessary to reduce the tax burden, to decrease the progressivity of taxation and to introduce a larger co-ordination of fiscal policies at the international level. Although the economic literature has widely evolved during the last decade, it seems unable to explain the fiscal policies of governments in highly integrated economies.
Moreover, the ongoing demographic trend has put the traditional welfare system under pressure: additional resources are needed as well as a revision of the private-public composition of welfare services, with consequences on the ways they are financed. The privatisation policies and the decline of investments in infrastructure have induced a complete revision of public services financing, with more importance given to price mechanisms rather than to taxation.
The increased average life expectancy and the reduced levels of birth rates induce a revision of the public pension system, developed in a socio-economic environment that was very different from the present one. In the meanwhile, the family structure evolution and the need of providing incentives to enter the labour market require the creation of a system to insure against the unemployment risk, as well as to improve the efficiency and equity of public expenditure programs addressed to individuals and families. The need of a more careful management of public finances has also induced a change in privatisation policies and investment in infrastructure and public services.
Summing up, the present research project aims to provide an answer to the following questions:
1. What is the effect of globalization on the structure of the fiscal systems, with particular reference to the level of tax burden, its composition and the degree of tax redistribution?
2. How do the changes of welfare systems induced by the ageing of the population and by globalization affect the structure of fiscal systems? Particular attention will be devoted to the privatisation of pension systems and of family assistance programs and to the increased targeting of job market policies.
3. How do the restructuring of the tax and welfare systems interact with the policies of privatization, and investment in infrastructure and public services, with particular attention to the European context?
Finally, the project includes a thorough analysis at the international level of recent reforms of tax systems. This institutional study is first developed at the country level. The main changes in the fiscal systems are then compared with other countries in the same and in different areas of the world economy. In particular, the institutional analysis has two main aims: not to interrupt the analysis of national fiscal systems funded by PRIN 2002, and to show the relevance of the issues dealt with in the present research project with reference to East Asia and Latin America. <<<

First Results

The Lecce Unit expects to complete the theoretical analysis of the effects of tax competition on the progressivity of fiscal systems and on human capital accumulation in general equilibrium models with perfect competition. Furthermore, it expects to start the theoretical investigation of the strategic interaction among national fiscal systems in a Economic Geography framework. This part of the research will be completed in the second phase by analyzing the scope for international coordination.
The Milano-Bocconi Unit expects to complete the description of the historical development of private welfare and the actual implementation in those countries where its presence dates back a few years. This Unit also expects to begin the theoretical analysis of the implications of the shift from public to private welfare and the collection of data to be used in the microsimulations in the second phase.
The Milano-Statale Unit expects to collect a data base which will be used to perform international comparisons of the trends of public investments and of the structure of public sector budget. Moreover this Unit expects to identify models of capital accumulation and financing for a number of public services, in particular those that are capital intensive.
The Pavia Unit expects to write a report on East Asia countries to describe the main features of their fiscal systems and how they have evolved over the nineties and it will then analyse the main taxes. It then examines the quantitative aspects of each system and its effects, in particular the level and the trend in the legal and effective tax rates, possibly taking into account some other indicators (fiscal pressure, tax wedges, sector allocation, personal redistribution, territorial allocation). Each report will afterwards investigate the reforms being implemented in the 90s, especially the most recent ones, and then end up with some concluding remarks. An overview paper will develop a comparative analysis of the evidence stemming from the single country studies.The research plans of all Units will be over.
We expect to have a number of papers from each research Unit and a concluding report giving the main results the whole research project by merging the conclusions of the single Units. <<<

Timescale

24 months

National and international background

Intensified international competition, ageing population, de-industrialisation, concern about the high level of taxation, changing roles in labour markets and households all pose a severe re-thinking about the scope and the ways of public intervention in the economy. The discussion over problems and strategies of reform is by now a long standing one and it is focused both on the expenditure and on the revenue side of the welfare state.
On the revenue side, a large literature has analyzed the effects of factor and good market integration on fiscal systems, with particular attention to the strategic interactions among fiscal policy choices of different countries (a large survey can be found in Wilson, 1999). This line of research was originally developed following the methodological approach of the optimal taxation theory (Gordon, 1983) mainly resorting to general economic equilibrium models with perfectly competitive markets, constant or decreasing returns to scale and no uncertainty. Public intervention is justified by the presence of public goods and by the necessity of income redistribution. The analyses conducted in this particular theoretical context agree on a series of conclusions: goods and factors market integration forces countries to reduce the public budget and to transfer the fiscal burden from mobile to less mobile factors; factors mobility reduces the opportunities of income redistribution; the process of economic integration requires fiscal policies coordination in order to avoid welfare reduction due to tax competition among countries involved in this process.
However, this theoretical literature, for how robust and coherent, it can be not able to describe convincingly the fundamental aspects of the main experiences of economic integration that have occurred in last years. Even though some trends are sufficiently clear and they appear to support the theoretical conclusions (such as the progressive reduction of tax rate on corporate income), data do not offer univocal answers to many other relevant aspects. First, a reduction of the effective fiscal burden on mobile factors (primarily capital) and an increase of that on mobile factors (mainly labour in the European Union) have not clearly occurred (Devereux et al. 2002, Eurostat 2003, Gorter, J. and R. De Mooji 2001). Secondly, there exist many and significant cases of small open economies (Bowles 2000, Rodrick 1997) which perform large redistributive policies. Finally, fiscal policies coordination remains extremely limited. The most recent literature tries to give more adequate explanations to the effects of globalization on fiscal systems, and two lines of research appear of particular interest for the research project: the first is based on a more accurate description of the role of the state in advanced economies; the second on a different description of market economies.
As to the first line, it is necessary to take into account, following Sinn (1995, 1996), that most public intervention is justified by the need to provide insurance for those risks that would otherwise not be insured on private markets. Among the main risks that cannot be insured are those that are associated to human capital investment that is specific to a particular firm or productive sector. The insurance with respect to these risks is supplied either by means of redistribution that is achieved by the fiscal system and the social expenditure, or by means of labour market regulations. In this particular perspective Estevez-Abe et. al. (2001) investigate the interactions between labour market regulations, unemployment protection programs and countries international patterns of specialization. The reciprocal influence generated by the technological choice and by the institutional structure presents some interesting aspects: the existence of strategic complementarities between the levels of investment specificity and the intensity of redistribution policies may in fact produce multiple equilibria and path dependency so that - from a normative point of view - the optimal answer to economic market integration is not the same for every country. In this direction, it may be particularly useful to refer to the notion of "organizational equilibrium" (Pagano, 1993; Pagano e Rowthorn, 1994).
The second line of research, which has been developed in the context of the larger literature of Economic Geography, is based on the study of the effects of fiscal system and of strategic interactions among countries in models that depart from the traditional walrasian framework and that include increasing returns to scale, product differentiation, trade costs, and monopolistic competition. These models show that globalization effects on fiscal policies depend not only on the degree of factors mobility but also on agglomeration effects and on the degree of goods mobility (Baldwin et al. 2003). Tax competition may not reduce taxes and the process of globalization can be compatible with high tax and public expenditure levels.
From an institutional point of view, we observe that fiscal systems are characterized by periods of stability alternated with periods of changes. After many "supply friendly" interventions in the 80s, new goals of reforms, sometime opposing, have characterized the 90s and are still at work. The main goals are due to the process of developing supranational identities and to the catching up of emergent countries. During the last ten years, harmonization processes and changes to the fiscal systems have been frequent. Fiscal pressure had either to be increased to reduce budget deficits, or to be reduced, to increase growth and employment. Integration and international competition of fiscal systems have been accompanied by greater decentralization. Equity, efficiency, and neutrality issues have been also subject to political constraints. Demographic pressure on welfare programs has required reforms of their financing. These elements of change have not affected North American, North European and North African countries (where main reforms took place during the '80s). However, they have significantly affected European, new EU Members, East Asian and Latin American countries.
As to the welfare systems, a considerable amount of conceptual and empirical work has been directed to identify alternative reform proposals and their impact on different economic variables (Diamond, 1998 and 2002, Sass and Triest, 1997, Hausman, 1980, Blundell and MaCurdy, 1999). Whatever the specific institutional features of these alternative proposals, most of them envisage a reduction in the role the government has in providing pensions, social assistance and medical care. They also point out the importance of a better targeting of public spending and of providing incentives to move from welfare to work. The proposed changes translate into lower benefits and lower support granted directly by the State and require a rethinking of the tax-benefit system. They also call for an increase in the private involvement in a field which has been typically dominated by public intervention. Private interventions intended to relieve households and individuals of the burden of a defined set of risks and needs are not absent in the social protection experience. What's new in the policy debate and academic research in the last years is the focus on individual arrangements and the importance attributed to freedom of choice as a value to be pursued in welfare design. Just looking at the debate and work on pension systems reform, one sees how the proposals of individual savings accounts as the instrument to save the strained finances of pay-as-you-go systems and to guarantee workers an adequate income during old-age are booming (Sorensen, 2003; Diamond and Orszag, 2002 who comment on the proposal of the President's Commission to strengthen social security; Mitchell and Utkus, 2004). Individual savings accounts place on the individual the responsibility to choose where to invest, the administrative costs associated with their management and the risk associated with their inadequacy and with the absence of post-retirement indexation. Their take-up and development however impinges on the use of fiscal incentives. In this framework, the State no longer provides benefits directly, but it intervenes indirectly through fiscal concessions; the latter are used as an instrument to guide individual choices and to strengthen the incentives to accumulate voluntarily resources which will cover the gap between the needs and what the State is willing to provide directly. Focusing on public assistance, in recent years various OECD countries have also started redesigning these programs to low-income families. The main aims of such changes have been to eradicate benefit dependency effects and to provide incentive to participate in the labour force. The side effects of such policies have been to reduce the burden of the welfare system costs and to target more efficiently the needy ones. During the 1990's the U.S. fundamentally changed the structure of its public assistance programs to low-income families. In contrast to earlier decades, when different design and lower generosity of the U.S. social welfare programs led U.S. policies to be dismissed as irrelevant or aberrant by other OECD countries, during the 1990s many of these countries watched the experiments of the U.S. with great interest (Blank, 2002). In the 1990s Canada introduced a demonstration program - the Self Sufficiency Project - designed to move women on welfare to work. In 1999, the U.K. enacted the Working Family Tax Credit, a generous tax credit for low-income working families, similar to the U.S. Earned Income Tax Credit program. In 2003 The WFTC was replaced by the Working Tax Credit for low-wage workers and the Child Tax Credit for families with children, which aim to provide a 'seamless bridge' between in work and out of work support for families as well as extending in work support to childless people (Leicester and Shaw, 2003).
Family policies can also help to offset population ageing. In order to rebalance the proportion of old and younger cohorts, which seriously affects the evolution of public accounts, attention has been placed on fertility rates and their links to the welfare system. Since Mincer's classic article (Mincer, 1985), most economists take for granted that there is an inverse relationship between fertility and female labour-force participation at the aggregate level. However, using data from the 1990's, several authors have recently noted an aggregate reversal in sign towards the positive association between these two variables among OECD countries (Bettio and Villa, 1998, Kohler, 2000, De Laat and Sevilla-Sanz 2004, among others).
Last, one of the consequences of globalisation processes has been the disentangling of state monopolies for the supply of public services. This process took place via two routes. First of all, from an economic point of view, the growing integration of economies has less and less supported the existence of legal monopolies, based over the long time period of building up of the public enterprise on the exploitation of economies of scale on a large national basis.
The second route has been, particularly in Europe, the institution of a legal framework for competition that was clearly against national monopolies and favourable to interstate agreements for the liberalisation of public services. An interesting example of this second route is the production of European directives for sectors originally excluded from the application of the norms for competition, as defined in the treatise of Rome and its subsequent modifications.
The co-existence of an economic and a legal mechanism, together with continuous changes of technology that reduce the importance of the economies of scale particularly for network utilities (Laffont and Tirole. 2000), has contributed in the last 20 years to a large flow of privatisations and liberalisations in the EU, as well as in economies in transition and in developing countries. A further important role in this process has been played by the fiscal crises. The consequent budget constraints for the public sector have determined more and more problems for governments to finance the investments in public enterprises, or to cover their budget deficits when revenues from tariffs were lower than running expenses (Morten, Hennessy, O'Brien, 1998).
There is a large consensus (Newbery 2000; Baldwin and Cave, 1999) on the relationship between globalisation, fiscal crises, technological progress and privatisation and liberalisation processes. However, the experience of the last 20 years on privatisation, liberalisation and regulation of public services shows a variety of ownership and organizational models. In some countries privatisations came many years before liberalisation, for example in the gas sector in Great Britain. In others liberalisations did not imply giving up public property, for instance in the case of the electricity sector in some Nordic countries. In some cases, as in France, in spite of the European directives, a remarkable resistance of vertically integrated industrial organizations is evident. In other countries the system has gone towards a wide vertical disintegration not necessarily accompanied by competitive markets.
In particular, the EU enlargement to countries presenting a consistent infrastructural gap with respect to the most developed area of the EU 15-countries, given the weak adjustment process of public sector budgets for the new member states, proposes a reflection on organizational and ownership models the new accessing countries will choose (Weder, 2001; Nuti, 2002). The need of reforming how public service are financed from general taxation to a mix of tariffs and project finance programs for public investments (Brixi, Polackova, 2000) should be also considered. Moreover, the drying up of revenues from privatisations in public budgets (that partly hid financing problems in the last few years) will certainly show its consequences in the next 10 years. In this perspective the role of the European Commission as a cofinancing body of ISPA projects (infrastructural and environmental sectors) in candidate countries has to be considered as a case-study. The European Commission is not a passive subject in this process but it can concur, as a cofinancing subject, to its evolution. Therefore methodologies for EU co-financing infrastructural projects in ISPA countries will be analysed in order to verify the influence of the European Regional Policy on the dynamic of organizational and ownership models in the new member countries. On this topic there is a wide literature about EU countries, but a comparative and evolutionary perspective that considers both the experience of the EU-15 countries and the enlarged EU is still missing. <<<