Comments on

1. Comments on ‘Flat but fair: a proposal for a sociall conscious flat tax rate in the Netherlands’ by Prof. Gradus Prof. Lothar Funk at the Centre for European Studies‘ event, Hotel Silken Berlaymont in Brussels, 23 June 2010

2. Structure • Background • Earlier Findings • New Ideas of the paper • Conclusions

3. Background (1) • While Benjamin Franklin may have been right that death and taxes are the only certain things in life, this certainty definitely does not extend to the way taxes are levied. • Tax systems are continuously changing as countries align their systems with evolving economic, political and administrative conditions. • This prompts the question: How can we best address the current and future challenges and improve the structure of our tax systems?

4. Background (2) • Apart from the large debt effects of the financial crisis, certain trends put the EU’s states under pressure. • Skill biased technological change and globalisation jeopardise the employment prospects of particularly the low skilled. • In addition, financial burdens will rise due to population ageing. • This will boost public expenditure on old age provision and health care. Simultaneously, globalisation makes it difficult for governments to meet the need for public resources since tax bases become more elastic.

5. Background (3) • In order to cope with these challenges, policy makers seek to boost employment, enhance education and improve labour market performance. • Additionally, governments often aim to broaden the financial basis of collective provision. • Economists argue increasingly that countries should replace their traditional progressive tax structures (i.e. rising marginal tax rates particularly in income taxes) by a flat income tax.

6. Background (4) • A main precondition for success of tax reforms according to OECD (2010): “Reform must balance efficiency and equity considerations as well as revenue and tax-avoidance concerns” (Making reform happen, pp. 103/5) • In general, structural policy reforms should form an important part of a strategy to exit from the recent crisis. • The crisis may even act as a driver to reform and may lead to renewed consolidation efforts. Even more important, they may not hurt the emerging upswing. • Rising public debt and declining private consumption may be causally related: consumers save more to compensate for public profligacy.

7. Earlier findings on flat tax reforms (1) • Defining feature of the flat tax appears to be a single positive marginal rate to labour income. • In Theory the simplicity of flat taxes encourages beneficial supply-side effects including not least improved compliance. • According to IMF (2007), however, recent flat tax reforms did not seem to have so-called Laffer curve effects empirically: Reductions in rates did not in itself lead to such an expansion of the base that revenue actually increased.

8. Earlier findings on flat tax reforms (2) • Evidence of success in the New Member States was mixed: Despite their flat taxes, tax wedges (including payroll taxes) are often comparable to those in high income OECD countries. The composition of the tax wedge appears rather unimportant for employment (dis)incentives. • Flat tax reforms were used to scale back exemptions, offering voters and lobbyists a clearer choice between a low rate and a narrow base. Efficiency increased in this respect in countries with such reforms.

9. Earlier findings on flat tax reforms (3) • The equity impact may be less adverse than it seems. Parallel to flat tax reforms personal allowances are often increased (the poor pay less than before) and compliance by those facing the largest cuts increases which may offset distributional effects. • Analysis for the Netherlands by Jacobs et al. (2007) holds that “replacing the current tax structure by a flat income tax harms labour market performance if income inequality is contained through higher tax credits. … A flat tax can raise labour market performance, but only if larger income inequality is tolerated”.

10. New Proposal by Prof. Gradus (1) • In order to avoid adverse distributional effects, the Dutch income-dependent health care contribution should be given a flat rate (as a cost effective solution). • Shifting additionally away from income taxes by increasing value-added-taxes and broadening the tax base allows for a lower flat tax rate. The latter may encourage training due to rising income differences. A falling replacement rate lowers the reservation wage and increase job searching and demand for labour due to more moderate wage demands. • All in all, this can boost efficiency, employment and growth through simplification and better incentives.

11. New Proposal by Prof. Gradus (2) • The arguments by Prof. Gradus are economically sound. What ultimately matters is the distributional and incentive impact of taxes and benefits as a whole. • Particularly and apart from administrative savings, “marginal decisions would be unbiased; decisions within a household would not be influenced by tax considerations year after year”. This may help to decrease the gender gap in the labour market. • Achieving such a result may become a role model for countries like Germany, as apart from efficiency also fairness aspects are reasonably addressed to increase political viability (though it still may prove difficult…).

12. Conclusions • Prof. Gradus offered a very stimulating paper which addresses convincingly the problems and objections against flat taxes of earlier proposals. • I hope that it will find with the aid of the CES many readers and will be debated widely not only among academics but particularly among policy makers. • Flat taxes that are implemented in a proper way may prove to be the way forward to considerably improve the sustainability of tax systems without hurting fairness.

13. Many thanks for your attention! The floor is now open to debate Prof. Gradus‘ excellent paper.