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Recession A Missed Opportunity To Improve Tax, Says IFS

by Robert Lee,, London

11 December 2015

Never let a good crisis go to waste. This is the conclusion of a new publication by the Institute of Fiscal Studies (IFS), which contends that the European countries required to make a substantial fiscal adjustment during the financial crisis have missed an opportunity to improve their tax systems.

In a special edition of its journal Fiscal Studies, the IFS examines how certain EU countries, including France, Germany, Ireland, Italy, Spain and the United Kingdom, responded to the recent recession in terms of their budgetary decisions. It shows that the largest fiscal adjustment by far was made by Ireland, which increased taxes by about six percent of national income and cut public spending by well over 10 percent of GDP, followed by Spain where tax hikes and spending cuts have been about half those in Ireland as a percentage of its economy.

The policy responses in France, Italy, and the UK were all similar in size - approximately five percent of GDP overall. However, the mix of tax increases and spending cuts differed markedly, with France and Italy relying largely on taxation to tackle their budget deficits, but the UK concentrating much more on spending cuts. Several years after the financial crisis broke, Germany on the other hand looks barely affected. Indeed, net taxes have fallen slightly, while there has been a relatively negligible cut in government expenditure.

However, the IFS did pick out one common theme from the various fiscal policy tools employed by these countries: "Unfortunately... these fiscal responses to the crisis largely missed opportunities to improve the overall efficiency of the tax system."

The IFS picks out three particular examples where tax measures served to distort tax systems further, rather than improve them: France's decision to introduce a corporate tax credit to encourage employment, rather than cut high employer social security taxes; Ireland's succession of VAT changes and capital gains tax hikes, with the latter tax having risen from 20 percent to 33 percent in stages from 2008, which have "unnecessarily created uncertainty and distortions"; and the UK's decision to raise its standard rate of VAT while retaining a relatively narrow VAT base, decisions which "have come at the cost of increasing distortions for both producers and consumers." The UK's individual income tax schedule has also been made "considerably more complicated," the IFS observed.

"With France, Ireland, Italy, Spain, and the UK all having planned and implemented large fiscal adjustments since the onset of the Great Recession, we might hope that policymakers would have tried to use this as an opportunity to improve the efficiency of the tax system and public spending in their countries. Or, at the very least, not to have exacerbated existing inefficiencies," the IFS said.

"Unfortunately, in many cases, the fiscal response to the crisis missed opportunities to improve the overall efficiency of the tax system."

TAGS: tax | Ireland | fiscal policy | budget | social security | France | Germany | Italy | Spain | individual income tax | Europe

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