Tax and Welfare Reforms: Stabilisation and Incentives Effects

Tax Policy Conference, p. 199, 2003

20 Pages Posted: 3 Jun 2012

See all articles by Marco Buti

Marco Buti

European Commission, DG II

Paul van den Noord

Organization for Economic Co-Operation and Development (OECD)

Date Written: April 3, 2003

Abstract

Reforms aiming at lowering the tax burden and cutting social benefits may boost efficiency and output, and improve market adjustment to shocks, but, by reducing the size of automatic stabilisers, may also imply less cyclical smoothing. This would be problematic in EMU given the loss of national monetary autonomy. This paper argues that the alleged trade-off between efficiency/flexibility and stabilisation depends on the typology of shocks affecting the economy. While higher taxes and benefits stabilise output in the event of demand shocks, if the initial tax burden is high, they may have destabilising effects in the event of supply shocks. As to inflation, very high taxes are destabilising thereby increasing the likelihood of a policy conflict with the central bank. Numerical simulations show that European countries – especially very open ones – may well have a tax burden above the threshold beyond which perverse output stabilisation effects in the event of supply shocks occur. Hence tax reforms may not only improve efficiency, but, if supply shocks prevail, also enhance cyclical stabilisation.

Keywords: Taxation, Tax Reforms, Automatic Stabilisers, Economic and Monetary Union, Shocks

JEL Classification: E52, E61, F42

Suggested Citation

Buti, Marco and van den Noord, Paul, Tax and Welfare Reforms: Stabilisation and Incentives Effects (April 3, 2003). Tax Policy Conference, p. 199, 2003, Available at SSRN: https://ssrn.com/abstract=2073383

Marco Buti (Contact Author)

European Commission, DG II ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium
+32 2 296 2246 (Phone)
+32 2 299 3505 (Fax)

Paul Van den Noord

Organization for Economic Co-Operation and Development (OECD) ( email )

Economics Department (ECO)
2 rue Andre Pascal
75775 Paris Cedex 16
France

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