Taxes and Inequality: Divergent Paths in Four Countries

Besides the effect of tax competition on inequality in the OECD at large, a diversity of national tax strategies with different redistributive consequences can be observed. In the following we illustrate this diversity by looking at four countries in more detail: Britain, France, Ireland and Denmark. Whereas Ireland and the United Kingdom, as liberal market economies, are less prone to state intervention, Denmark and France are welfare states with a strong tradition of government interventions in markets. In each group we choose a large and a small country to represent the potential winners and losers of asymmetric tax competition.

Table 5.2 provides an overview of the four countries’ tax policies and a number of different inequality measures. It shows that although both market and net income inequality have increased in the OECD as a whole over the last three decades, market Gini coefficients are now twice as high as net Gini coefficients, suggesting that market forces are the primary driver of rising inequality (Solt 2009; OECD 2011). Nonetheless, we can observe quite different inequality developments in the four countries. In Britain, both Gini coefficients have increased but with a larger increase in the net Gini. This suggests that the British government has lost redistributive capacities. Similarly, in Denmark, both Gini indices have risen; however, in this case the market Gini has increased by more, suggesting that the Danish government has been able to offset some

Britain

France

Ireland

Denmark

OECD

average

Year3

1980s

2010s

1980s 2010s

1980s 2010s

1980s

2010s

1980s

2010s

Top marginal tax rates

Personal income

60

45

60

54

60

48

65

56'

57

37

Corporate income

52

21

50

34

45

13

40

25

43

24

Value added

15

20

17

20

25

23

25

10

17

Tax revenue as % of total taxes

Personal income

40

28

11

17

25

32

56

51

30

24

Corporate income

6.2

8.6

5.2

5.7

4.8

8.9

4.8

5.8

7.6

8.5

On goods and services

18

18

30

25

43

35

38

32

32

32

Economic inequality

Market Gini

44

50

38

52

47

40

47

53

40

46

Net Gini

29

36

29

28

33

29

25

26

26

28

Market Gini: % change11 Net Gini:

13

36

-15

12

18

% change11

24

-2

-11

6

7

Source-. OECD (2014) and Solt (2009)

aYear: Data for 1980s ranges from 1975 to 1981 and data for 2010s ranges from 2010-2014 bAverage annual change in percentage from mid 1980s to late 2000s

'Denmark's top rates are extracted from EU (2013) and Ganghof (2005) as the OECD does not include a number of subnational taxes, which form part of the personal income tax market inequalities. We can observe a similar trend in France with the difference that the French government has increased redistribution in order to decrease inequalities in disposable incomes. Ireland is the only OECD country where both Gini measures have decreased since 1980. This diversity in inequality developments suggests that domestic political and structural factors condition how economic globalization affects tax policy-making and, with it, economic inequality.

Let us first turn to the British case to better understand the link between tax policy-making and economic inequality. In this case the shift from direct to indirect taxes is particularly pronounced. The drastic fall in direct tax rates has been accompanied by an increase in the general consumption tax rate. Similarly, the amount of revenue extracted from these sources has changed. While we observe a considerable decline in revenue from direct taxes, the income from taxes on goods and services has remained stable. In Britain, indirect taxes amount to over 25 per cent as a share of household disposable income for the lowest quintile and less than 10 per cent for the top quintile (Joumard et al. 2012, 20). Along with the shift away from the taxation of top incomes since the 1980s, we observe a drastic increase in all our measures for economic inequality. Britain thus represents a scenario illustrated by scholars of the efficiency school: its engagement in international tax competition has not attracted sufficient foreign incomes and investments, and hence the tax burden has shifted to less mobile tax bases with significant redistributive implications.

The French case highlights that the British development towards less redistributive forms of taxation and higher levels of inequality is by no means structurally determined. France, as one of the largest European countries, still has relatively high direct tax rates. Moreover, we observe a trend towards higher revenues from direct taxes rather than consumption taxes. Although France has experienced a drastic rise in market income inequality since the 1980s, its strong reliance on progressive forms of taxation has been accompanied by a decline in net income inequality. This co-development suggests that governments have not lost the ability to maintain redistributive tax policies, but that the ability and willingness of political actors strongly depends on domestic political processes and institutions, as highlighted by scholars of the compensation school.

Like England and France, our two small cases—Denmark and Ireland—have followed very different tax strategies since the 1980s, with diverse outcomes for economic inequality. Whereas Ireland has managed to combat market inequality, Denmark has allowed market inequality to rise but has increased redistribution. The Danish government still applies high top tax rates on personal incomes and has kept its revenue mix relatively stable, even with a small decrease in income from indirect taxes. Despite its move to a dual income tax system, Denmark still has strong redistributive capacities. The introduction of a dual income tax system, along with taxing capital and corporations at a low and flat rate while keeping a progressive tax system for wage incomes, has allowed the level of inequality to remain relatively stable.

Ireland is an example of a successful tax haven. Its governments from the left and the right have supported drastic corporate tax cuts down to 12.5 per cent—far below the OECD average of 25 per cent—to attract foreign capital. This low-tax strategy has been successful in leading not only to more investments but also to more employment and higher wages. As revenue statistics show, the Irish government doubled its income from corporations and personal income tax revenue has increased since the 1980s. Furthermore, the VAT rate was lowered in contrast to the majority of OECD countries. By inducing vast inflows of foreign capital via low direct taxes, Ireland has managed to reduce market inequalities. Moreover, the Irish tax system has maintained its redistributive capacity by, for example, compensating for a drop in the top personal income tax by reducing the VAT rate as well.

In sum, the four cases show not only that governments have at their disposal a number of tax choices, which seem to have co-developed with different inequality patterns, but also that similar tax responses can have different outcomes. For instance, Britain and Ireland have adopted a similar low-tax strategy, but the effect on inequality has differed. By contrast, the two small countries, Ireland and Denmark, have opted for different tax responses. The Irish government has engaged in international tax competition, while Denmark has opted for a moderate response. Accordingly, Ireland has mainly addressed income inequality via the market, while Denmark has done so via redistribution. Moreover, Denmark and France have both opted for a middle way, cutting direct taxes to some extent but nonetheless maintaining the redistributive capacity of the state. There is no structural determinism at work since these governments still have room to manoeuver with highly integrated market economies.

 
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