Tag: Tax reforms
Latvia Stumbling Towards Progressive Income Taxation: Episode II
In August 2017, the Latvian parliament adopted a major tax reform package that will come into force in January 2018. This reform was a long-awaited step from the Latvian authorities to make the personal income tax more progressive. Some of the elements of the adopted reform, e.g. the changes in the basic tax allowance are estimated to help reducing the tax wedge on low wages and help addressing the problem of high income inequality. At the same time, the way the newly introduced progressive tax rate is designed will effectively lead to a reduction in the tax burden on labor and will hardly introduce any progressivity to the system.
In recent years, reducing income inequality has become one of the top priorities of the Latvian government. Income inequality in Latvia is higher than in most other EU and OECD countries, and the need to address this issue has been repeatedly emphasized by the Latvian officials, the European Commission, the World Bank and OECD.
The main reason for high income-inequality is a low degree of income redistribution ensured by the tax-benefit system. The personal income tax (PIT) has been flat since the mid-nineties. While the non-taxable income allowance introduces some progressivity to the system, the Latvian tax system is characterized by a very high tax burden on low wages, compared to other EU and OECD countries.
Since the beginning of 2017, the government has worked on an extensive tax reform package that was passed in the parliament in August and will become effective as of January 2018.
Two years ago, we wrote about the tax reform of 2016. In this brief, we estimate the effect of the 2018 reform on the tax burden on labour and income inequality. We will only consider changes in direct taxes on personal income – the changes in enterprise income tax and excise tax are outside the scope of our analysis. Parts of our estimations are done using the tax-benefit microsimulation model EUROMOD (for more details about the EUROMOD modelling approach, see Sutherland and Figari, 2013) and EU-SILC 2015 data.
Tax reform 2018
We focus our analysis on four elements of the reform that are expected to affect income inequality and that are described below. In our simulations, however, we take into account all changes in the PIT rules.
First, the flat PIT rate of 23% will be replaced by a progressive rate with three brackets: 20% (applied to annual income not exceeding 20,000 EUR), 23% (for annual income above 20,000 EUR and below 55,000 EUR) and 31.4% (applied to income exceeding 55,000 EUR per year).
Second, the maximum possible PIT allowance will be increased and the structure of the PIT allowance will be made more progressive. Latvia has a differentiated allowance since 2016, which means that individuals with lower incomes are eligible for a higher tax allowance. Figure 1 shows the changes in the non-taxable allowance that will be introduced by the reform. Another important change is that the differentiated allowance will be applied to the taxable income in the course of the year. The current system foresees that, during a calendar year, all wages are taxed applying the lowest possible allowance (60 EUR per month in 2017), but workers eligible for a higher allowance have to claim the overpaid tax in the beginning of the next year.
Figure 1. Basic PIT allowance before (2017) and after (2018-2020) the reform, EUR
Source: compiled by the authors.
Third, the rate of social insurance contributions will be increased by 1 percentage point. Social insurance contributions are capped and the cap will be increased from 48,600 EUR per year to 55,000 EUR per year, i.e. to the same income threshold that divides the top PIT bracket.
Finally, the reform will modify the solidarity tax – a tax, which was introduced in Latvia in 2016 and which is paid by top income earners. When this tax was initially introduced, one of its objectives was to eliminate the regressivity from the tax system caused by the cap on social insurance contributions. Hence, the rate of the solidarity tax was set at the same level as the rate of social insurance contributions and was effectively replacing social insurance contributions above the cap. The reform foresees that part of the revenues from the solidarity tax (10.5 percentage points) will be used to finance the top PIT rate. This element of the reform implies that after January 2018 those falling into the top PIT bracket will, in fact, not face a higher PIT rate than those falling into the second income bracket – the introduction of the top rate will be offset by the restructuring of the solidarity tax.
Results
There are four main findings. First, the reform will reduce the tax wedge on labor income, whereas the tax wedge on low wages will remain high by international standards. Second, most of the PIT taxable income earners (93.5%) will fall into the bottom income bracket. Hence the reform will effectively reduce the tax burden, while the effect on progressivity is very limited. Third, the (small) increase in tax progressivity is ensured mainly by changes in the tax allowance, while the effect of changes in the tax rate on progressivity is negligible: Even those few PIT payers that fall into the top tax bracket will not experience any increase in the tax burden due to a compensating change in the solidarity tax. Finally, it is mainly the households in the middle of the income distribution that will gain from the reform.
Effect on tax wedge
We start with a simple comparison of the average labor tax wedge in Latvia and other OECD countries for different wage levels before and after the reform. The tax wedge measures the share of total labor costs that is taxed away in the form of taxes or social contributions payable on employees’ income.
Table 1. Average tax wedge for single wage earners without dependents in Latvia and other OECD countries, before and after the reform
|
67% of average worker’s wage |
100% of average worker’s wage |
167% of average worker’s wage |
|
| OECD average in 2016, % (a) | 32.3 | 36.0 | 40.4 |
| Latvia 2016, % (a) | 41.8 | 42.6 | 43.3 |
| Latvia’s rank in 2016* (a) | 6 | 11 | 16 |
| Latvia 2018, % (b) | 39.4 | 42.3 | 42.6 |
| Latvia 2019, % (b) | 39.1 | 42.1 | 42.6 |
| Latvia 2020, %(b) | 39.0 | 41.9 | 42.8 |
Source: (a) OECD and (b) authors’ calculations. Note: * Ranking across 35 OECD countries. Higher ranking implies higher tax wedge relative to other countries.
Table 1 shows that the tax wedge on low wages (67% of an average worker’s wage) in Latvia is pretty high. In 2016, it was the 6th highest across OECD countries, while the tax wedge on high incomes (167% of the wage) is much closer to the OECD average.
While the reform will slightly reduce the tax wedge for low wage earners (from 41.8% to 39.0% in 2020), it will still remain high by OECD standards. Despite an increase in PIT rate for high-income earners, the reform will also lower the tax wedge for those who earn 167% of the average wage. Why? The explanation comes from the income thresholds for the tax brackets. The income of those earning 167% of the average wage is estimated to fully fall into the first tax bracket in 2018–2019 and only slightly exceed the income bracket for the second PIT rate by 2020. This means that most of the incomes of people earning 167% of the average wage will be taxed at the rate of 20%, which is lower than the current flat rate of 23%. Moreover, in 2020, only a small share of their income will be taxed at 23% – the same rate that these individuals would have had faced in the absence of the reform. Hence, we observe a reduction in the tax wedge for high-income earners.
Generally, only a very small share of taxpayers will fall into the middle and the top income brackets. According to our estimations, as many as 93.5% of all PIT taxable income earners will fall into the lowest income bracket, and only about 6.5% will fall into the second income bracket and about 0.5% will face the top PIT rate.
Apart from the progressive PIT schedule, the reform envisages important changes in the solidarity tax. As explained above, part of the revenues from the solidarity tax will be used to finance the top PIT rate. Therefore, even those (very few) taxpayers whose income will exceed the threshold for the top PIT rate, will not experience any increase in the tax burden because of the compensating change in the solidarity tax. Therefore, the reform will effectively reduce the tax burden on labour with very little effect on progressivity.
While lowering the tax burden is generally welcome, the motivation for applying the top rate to such a small group of taxpayers is not clear. For example, in their recent in-depth analysis of the Latvian tax system, the World Bank (World Bank, 2016) came up with a tax reform proposal that envisaged a considerably lower threshold for the top PIT rate, which, according to our estimations, would cover about 12% of the taxpayers. Given the limited budget resources and an especially high tax wedge on low wages, a more targeted reduction in the tax burden would be preferable. Similar concerns about insufficient reduction in the tax burden on low-income earners are expressed in the latest OECD economic survey of Latvia (OECD, 2017).
Effect on income distribution
Below we present the results from the tax-benefit microsimulation model EUROMOD. Figure 2 shows the simulated change in equivalized disposable income by income deciles compared to the baseline “no-reform” scenario in 2018-2020.
Figure 2. Change in equivalized disposable income by income deciles caused by the reform compared to “no-reform” scenario, %
Source: authors’ calculations using EUROMOD-LV model
The first thing to note is that these are mainly households in the middle of the income distribution who will gain from the reform – their income will increase due to both the increase in non-taxable allowance and the introduction of the progressive rate.
The gain in the bottom of the income distribution is smaller for several reasons. First, the proportion of non-employed individuals (unemployed and non-active) is larger in the bottom deciles. Second, individuals with low wages are less likely to gain from the reduction in the tax rate and the increase in the basic allowance, since they might already have most of their income untaxed due to the currently effective basic allowance. The same applies to pensioners who have a higher basic allowance than the employed individuals and who are mainly concentrated in the bottom of income distribution.
Our results suggest that the wealthiest households will also see their incomes grow as a result of the reform (by about 1% in 10th decile). The growth is ensured by the fact that annual income below 20,000 EUR will be taxed at a reduced rate of 20%, and, taking into account that even in the top decile only about half of the individuals get income from employment that exceeds 20,000 EUR per year, the gain from the tax reduction is considerable even in the top decile. A reduction in the tax allowance for high-income earners will have a negative effect on wealthy individuals’ income, but this will be more than compensated by the above positive effect of the change in the tax rate. Hence, the net effect on the incomes in the top deciles is estimated to be positive.
Finally, Table 2 summarizes the effect of the reform on the income distribution, measured by the Gini coefficient on equivalized disposable income. On the whole, the reform is estimated to slightly reduce income inequality – in 2020, the Gini coefficient is expected to be 0.6 points lower than it would have been in the absence of the reform. This reduction is mainly driven by the changes in the non-taxable allowance, while the three PIT rates are estimated to have an increasing impact on income inequality.
Table 2. Gini coefficient on equivalized disposable income in the reform and “no-reform” scenario
| 2018 | 2019 | 2020 | |
| “No-reform” scenario | 35.2 | 35.4 | 35.7 |
| Reform scenario | 35.0 | 35.0 | 35.1 |
Source: authors’ calculations using EUROMOD-LV model
Conclusion
The 2018 tax reform was a long-awaited step from the Latvian authorities on the way to a more progressive tax system. The planned changes in the basic tax allowance are estimated to help reducing the tax wedge on low wages and help addressing the problem of high income-inequality.
At the same time, the second major aspect of the reform, the introduction of a progressive PIT rate, raises more questions than answers. The progressive rate, the way it is designed, will effectively lead to an across-the-board reduction of the tax burden on labor and will hardly help to reach the proclaimed objective of taxing incomes progressively. Given the limited budgetary resources and given that taxes on low wages will remain high compared to other countries even after the reform, a more targeted reduction of the taxes on low-income earners would have been a more preferred option.
References
- OECD, 2017. “OECD Economic Surveys: Latvia 2017”, OECD Publishing, Paris. http://dx.doi.org/10.1787/eco_surveys-lva-2017-en
- Sutherland, H. and Figari, F., 2013. “EUROMOD: the European Union tax-benefit microsimulation model”, International Journal of Microsimulation, 1(6), 4-26.
- World Bank, 2016. “Latvia Tax Review”, available at http://fm.gov.lv/files/nodoklupolitika/Latvia%20Tax%20Review%20Draft%20231216%20D.pdf
Effects of International Taxation on Firm Valuation: Evidence from Japan’s 2009 Tax Reform
This brief highlights the results of a study of Japan’s 2009 adoption of a territorial tax regime exempting corporations’ foreign earnings from domestic taxation. We examine stock market reactions to events leading to the adoption of a dividend exemption system. We use an event study methodology leveraging firm characteristics and accounting for confounding effects from recent financial market developments. We find that relative to other Japanese multinationals, firms facing lower effective tax rates on their foreign operations benefit disproportionately from the reform. Surprisingly, firms with less foreign exposure and fewer opportunities for tax avoidance experience relatively larger abnormal returns overall. We attribute these gains to a combination of enhanced opportunities for international expansion among smaller domestic firms, direct tax savings on undistributed foreign earnings, and general cultural biases against tax planning.
As firms’ operations have expanded their global reach, corporate taxation has become inextricably tied to the taxation of multinational firms’ (MNCs’) foreign earnings. Correspondingly, international tax issues including tax avoidance, tax competition, and multinational competitiveness have dominated discussions on corporate tax reform. Much of the debate focuses on the choice over worldwide (residence-based) versus territorial (source-based) taxation. This brief summarizes a study by Bradley, Dauchy, and Hasegawa (2014) in which we aim to capture the full range of possible effects of Japan’s 2009 adoption of a 95 percent foreign dividend exemption system on firm after-tax profitability by examining stock market reactions around key events leading to the reform. More specifically, our study looks into abnormal stock returns (ARs) defined as extra-normal firms’ returns below or beyond what the market would have predicted, absent the event. ARs surrounding key event dates leading to the reform are used to quantify current and future tax savings on repatriated earnings as well as benefits flowing from firms’ enhanced ability to compete in foreign markets.
Japan’s 2009 Tax Reform
From 2003 to 2009, 10 OECD countries switched from worldwide to territorial tax regimes; the latest and most consequential among these being Japan and the United Kingdom. Motivated by a desire to encourage domestic reinvestment of accumulated foreign earnings, and to enhance Japanese firm competitiveness in foreign markets through reduced tax and compliance costs, the Japanese dividend exemption system arose from a short succession of tax policy discussions. Given the tightly structured nature of Japan’s annual tax reform process, the most informative and authoritative events in the sequence that we consider, are thus the initial May 9, 2008 announcement. The Ministry of Economy, Trade, and Industry (METI) was then instructed to analyze the consequences of adopting a territorial tax regime. This announcement was followed by two subsequent Cabinet meetings, in which details of the proposed reform were refined and ultimately endorsed on June 27, 2008 and January 23, 2009, respectively.
Our data and identification strategy
For our analysis, we use data from Datastream, which consist of daily stock market returns for the largest quartile (by market capitalization) of publicly listed Japanese, U.S., and German firms. These data are combined with annual financial statement information from Orbis on each publicly listed Parent Corporation and all of their foreign subsidiaries. Adapting the standard market model event study methodology, returns on U.S. and German market portfolios are incorporated in our determination of abnormal Japanese stock returns. This is to control for potential confounding events associated with the global financial crisis. Conversely, we also study possible spillover effects of the reform in the U.S. and German markets. The idea is to identify whether the Japanese reform may have affected the prospects for adoption of a territorial tax regime in the U.S.—which now accounts for around 80 percent of GDP among the remaining OECD worldwide regimes – or how this may have affected U.S. and German firm competitiveness, the latter being subject to a dividend exemption system very similar to Japan’s under Germany’s long-standing territorial tax system. Significant differences in investor reactions across the Japanese, U.S., and German markets around our event dates are hence informative about the different channels by which the Japanese reform was perceived to impact firm after-tax profitability.
Figure 1. Cumulative Abnormal Returns on May 9, 2008, by Firm Nationality and Multinational Status.
Notes: This figure plots cumulative abnormal returns (CARs) within a 5 trading-day window centered around the May 9, 2008 event, defined as the sum of daily ARs. ARs are the mean cross-sectional prediction errors derived from estimation of the standard market model including market portfolio returns drawn from the Japanese, U.S., and German exchanges over the last 250 trading days ending 20 days before the first event. Tests of statistical significance (in red) follow Kolari and Pynnönen’s (2010) “adjusted BMP” methodology.
Moreover, we leverage the location of foreign subsidiaries and financial statement characteristics of both parents and subsidiaries to estimate in a single step the contribution to ARs from particular firm attributes. Among these, we emphasize simple distinctions between domestic and multinational firms, or the ownership of at least a single subsidiary in a tax haven, as a proxy for tax planning sophistication. A direct measure of tax savings on the repatriation of accumulated foreign earnings is calculated as the difference between the average effective tax rate on domestic and foreign operations. Further interactions of this potential tax savings rate with measures of intangible intensity are intended to distinguish prospects for future tax savings on intangibles-facilitated income reallocation.
Unexpected Winners
A striking point that emerge from Figure 1 is that Japanese market reactions generally appear larger in magnitude among domestic firms than MNCs. Statistically-significant 1-2 percent cumulated abnormal returns (CARs) observed among the former group appear to validate one of the Japanese reform’s objectives of facilitating expansion of smaller firms into overseas markets (Toder, 2014).
It is also noteworthy that the positive effect on Japanese firms is unmet by comparable reactions in either German or U.S. markets, such that the observed effect in Japan is more credibly attributable to the METI announcement — itself evidently either ignored or perceived as unimportant for U.S. and German firm profitability.
Table 1. Cumulated Event Date AAR Effects by Nationality and MNC Status
Notes: Significance levels are designated as *** (1 percent), ** (5 percent), and * (10 percent). Cumulated marginal effects measure ARs averaged over each three-day event window (AARs) and summed across Cabinet meeting dates.
These results appear to be reinforced after accounting for key firm characteristics, albeit in a nuanced way. Over the course of the full sequence of three Cabinet meeting dates, Japanese MNCs experienced significantly worse cumulated average abnormal returns (AARs) than their domestic counterparts, equal to a difference of 3.8 percent of market capitalization through the end of the January 23, 2009 event window (see Table 1).
As Predicted, Firms with Larger Tax Savings Potential Are Net Winners
Underlying these differences by multinational status, the rate of anticipated tax savings resulting from the reform is nevertheless associated with substantial positive effects on Japanese MNC valuations, with the largest such contributions arising around the last Cabinet meeting date. Over the course of all three events, a 10-percentage point increase in the tax savings rate was associated with AARs of 0.31 percent (top panel of Table 2). Applied to the set of Japanese firms in our sample with an observed average tax savings rate of 21.5 percent, this implies aggregate savings just slightly in excess of predicted tax savings on the repatriation of ¥17 trillion in undistributed earnings held by foreign subsidiaries of Japanese firms in fiscal 2006 according to the best available estimates prior to reform (METI, 2008).
Table 2. Cumulated Event Date AAR Effects among MNCs, by Nationality
Notes: See notes for Table 1.
More sophisticated or tax aggressive firms with subsidiaries located in tax havens performed relatively worse than other Japanese MNCs, while firms in industries characterized by heavier reliance on intangibles likewise saw no additional gains in relation to potential tax savings on future shifted earnings.
Conclusion
Our study reveals that the Japanese adoption of a territorial regime was, at least initially, perceived as being disproportionately valuable for firms that might previously have been deterred from expanding overseas due to international tax compliance issues and lack of competitiveness under the previous worldwide regime, consistent with one of the motives for the reform. More tax savvy Japanese MNCs may have benefited disproportionately less, in part, because the previous regime was not limiting their ability to borrow from their affiliates, or simply because of a lack of interest in tax planning, as is widely reported among tax practitioners.
Our study confirms the importance of the most direct source of gains from adoption of a territorial tax regime – namely, the tax savings on immediate repatriations. At the same time, it highlights the perceived benefits among aspiring entrants into foreign markets of reductions in tax compliance costs and enhanced competitiveness in foreign markets.
▪
References
- Bradley, Dauchy, and Hasegawa. CEFIR/NES WP Series, No. 201, September 2014. http://www.cefir.ru/index.php?l=eng&id=35
- Kolari, J. and S. Pynnönen (2010), “Event Study Testing with Cross-sectional Correlation of Abnormal Returns,” Review of Financial Studies, Vol. 23, No. 11, pp. 3996–4025.
- Ministry of Economy, Trade and Industry of Japan (2008), “Repatriations of Foreign Profits by Japanese Enterprises: Toward the introduction of a dividend exemption regime (In Japanese: Wagakuni Kigyo no Kaigairieki no Kanryu nitsuite).” http://www.rieti.go.jp/en/columns/a01_0387.html#note2.
- Toder, Eric (2014), “Review of the Conference on What the United States Can Learn from the Experience of Countries with Territorial Tax Systems,” Urban Institute, Washington D.C., June 18. http://www.urban.org/publications/413159.html
Polish Pre-Election Polls Seem Unmoved by Electoral Giveaways
As in every election, numerous electoral pledges have been made prior to the election that will take place in Poland on the 9th of October. It seems however, that support for different parties has remained largely unaffected by the scale of the giveaways.
As in every elections, numerous electoral pledges have been made prior to those that will take place in Poland on the coming Sunday, the 9th of October. It seems, however, that support for different parties has remained largely unaffected by the scale of the giveaways.
As the elections get nearer, the electoral race between the main contenders, the ruling Civic Platform (PO, popular support at about 32%) and the main opposition party Law and Justice (PiS, 29%), seems to be getting closer, with the result of Sunday’s vote remaining wide open. Behind the two leaders in opinion polls are the Polish People’s Alliance (PSL, 5%) which has been in coalition with PO for the past four years, and the Democratic Left Alliance (SLD, 10%) together with two recently formed parties – Palikot’s Movement (RP, 8%) and Poland is Most Important (PJN, 2%). To guarantee seats in the parliament any of the parties need to cross the 5% support threshold.
In the second part of its Pre-election Report published on 28th of September, the Centre for Economic Analysis (CenEA) presented a detailed analysis of electoral proposals focused on tax and benefit policies which would directly affect the financial situation of Polish households (Myck, et al., 2011a).
The two coalition parties (PO and PSL) have approached electoral declarations with surprising modesty by either fuzzy non-specific commitments (like the PSL) or electoral slogans which sound generous but are in fact relatively cheap to implement. The Civic Platform promised a “radical increase in the tax credit for the third and subsequent children in the family”. As the Report shows this would only affect about 30% of “3+” families or about 5% of all Polish families, and would cost only about 70m euro per year (0.02% of the GDP) – a burden that may be possible to bear even at the difficult times of the crisis.
The opposition parties are much more generous with PiS and SLD both offering to increase pensions and broaden eligibility criteria for family benefits. These policies in each case would cost about 1,5 billion euro (0.5% of the GDP). On top of that the SLD proposed a new benefit for low income families who cannot take advantage of the existing child tax credit. This policy would stretch the government’s budget further by another billion euro. Neither of the two parties suggest convincing ways of financing of the proposals and they are both adamant that they would not raise taxes.
The most stunning proposals came from the recently formed PJN, a party established after last year’s presidential elections by former members of PiS close to the late President Lech Kaczyński. PJN’s program promises extremely generous additional resources for families with children. When put together with additional proposals of changes in personal taxes, and minimum pensions the overall cost of the giveaways adds up to about 17bn euro, or about 5% of the GDP. Some of the resources for this purpose would come from introducing a uniform rate of the VAT, but the full package still leaves a hole in of about 12 billion euro (3.7% of the GDP). This cost seems impossible to pay at the time when the government is struggling with a very high level of debt and desperately tries to reduce the budget deficit.
The recent discussions concerning the parties’ spending plans may be one of the reasons behind the narrowing of the gap between PO and PiS, but other more generous electoral promises of other parties – do not seem to have caused much change in support. In fact, the party which has recently gained most in the polls (RP) is the only one which, with its suggestion of linear income tax and a uniform VAT rate – both at 18%, would significantly raise household taxes by nearly 3% of the GDP.
Such outcome may be interpreted in many different ways. First, it might relate to the failure of parties to clearly explain which population group would gain once the proposed changes get implemented. Secondly, the public opinion may generally have poor understanding of consequences of different solutions. It must be said that for a long time the campaign focused much more on personalities and several general issues than on specific details and proposals in the area of taxation or social support. Moreover, as demonstrated in the first part of CenEA’s Pre-election Report (Myck et al., 2011b), the ruling parties over the last two terms of parliament have generally failed to deliver their earlier promises related to tax and benefit policy. This may have made voters skeptical of what has been announced this year. The slogan that “no one will give you more than the politicians will promise” has been very popular in Poland over the recent weeks. Such slogans get reinforced by the fact that parties fail to identify convincing sources of funding for their new policies.
Politicians who want their promises to be taken seriously must realize that any proposed additional expenses may only be financed by extra taxes or through credible solutions concerning savings. The experience of this year’s campaign in Poland shows that until both sides of the equation are taken seriously by the parties, voters won’t pay too much attention to what is announced.
References:
Myck, M., Morawski, L., Domitrz, A., Semeniuk, A. (2011a) „Raport Przedwyborczy CenEA, część I. Wybory parlamentarne 2011: kto zyska, a kto straci i ile to będzie kosztowało?” (CenEA’s Pre-election Report. Elections 2011: who will gain, who will lose and how much it will cost?), Microsimulation Report 02/11, Centre for Economic Analysis, Szczecin.
Myck, M., Morawski, L., Domitrz, A., Semeniuk, A. (2011b) „Raport Przedwyborczy CenEA, część I. 2006-2011: kto zyskał, a kto stracił?” (CenEA’s Pre-election Report: 2006-2011 who gained and who lost? ), Microsimulation Report 01/11, Centre for Economic Analysis, Szczecin.
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
Incomes of Polish Households in the Context of 2005-2011 Tax and Benefit Reforms: A Pre-Election Analysis
On October 9, Polish voters will decide who will form the new government. In an analysis of tax and benefit reforms introduced over the last two terms of Parliament, the independent Centre for Economic Analysis, CenEA, examines who gained and who lost on the implemented changes. The reforms that have been implemented since 2006 include significant tax reductions and important changes to family benefits, as well as a recent increase in the VAT. In the context of declarations made in earlier electoral campaigns, the actually implemented economic policies introduced, offer little guidance to the voters regarding the reliability of promises made during this current campaign.
The last two terms of office for the Polish parliament includes the period October 2005 till November 2007, and the current four-year term which followed a snap-election in 2007, and which will now come to an end with parliamentary elections scheduled for October 9.
During 2005-2007, the ruling coalition was led by the Law and Justice party (PiS) who then lost the 2007 elections to the Civic Platform (PO). This year, these two parties remain the main contenders for electoral victory.
The years since 2005 have been marked by a series of significant reforms with substantial influence on disposable incomes of Polish households. These reforms are analyzed in the first Pre-election Report recently published by the independent Centre for Economic Analysis, CenEA (Myck et al., 2011). This report analyses the extent of the most important economic reforms undertaken in the last two terms of office and their distributional consequences. The analysis is done using the Polish microsimulation model SIMPL based on a dataset from the Polish Household Budgets’ Survey.
The report considers the following economic reforms:
- reductions in disability rates of social security contributions (SSC) in 2007 and 2008,
- introduction of a generous child tax credit (CTC) in the personal income tax system in 2007,
- introduction of a two-rate (18% and 32%) instead of a three-rate (19%, 30%, 40%) system of personal taxation (PIT reform) in 2009,
- a series of reforms to the means-tested system of family benefits (FB) in 2006 and 2009,
- a VAT reform which increased the basic rate from 22% to 23% and changed the operation of lower rates at 5% and 8% instead of 3% and 7%.
Source: based on Myck et al. (2011), Table 4.
Annual values are given in Euros; differences in SSCs are computed as net changes accounting for changes in the public sector’s employer contributions. Exchange rate: 1 Euro = 4.3595 PLN.
While the big reforms grabbed the headlines, subsequent governments which oversaw their implementation, followed the policy of raising taxes and lowering expenditures through policies of freezing the value of tax credits and eligibility thresholds for family benefits. In the latter case, this generated a reduction in the number of children eligible to family benefits by 18%. At the same time, the value of benefits to those receiving them increased, on average, by 60%, with the net effect being a 7% increase in family benefit spending.
It is shown in our report that the reform package implemented in the 5th term of Parliament, and which included, in particular, the SSC reforms (2007/08), the CTC (2007), and a reform of the FB system (2006), has been distributed very evenly across different income groups. Households in income deciles 1-9 saw their incomes grow by about 4.5%, while those in the top decile gained about 3%. The implementation of the tax reform in 2009 brought about significant gains only to high income households. This tax reform was legislated prior to the financial crisis in 2008. The policy of freezing tax credits and benefit-eligibility thresholds, introduced in 2008 and 2011, resulted in losses for middle-income groups but meant that the bottom decile gained about 1%. This was largely through changes in the value of family benefits for families receiving them.
The entire 2006-2011 package of tax and benefit reforms, had a direct impact on households’ incomes since it increased real disposable incomes, on average, by 5.4%. Here, the households in the top income decile gained the most (9.2%). The lowest gains were found in the 3rd decile (3.4%). Moreover, the poorest 10% of households gained, on average, 5.7% from the introduction of the entire package.
The nature of these reforms had an interesting distribution in terms of age and family type with the highest gains going to working-age individuals, in particular to married couples with children (10.2%). On the other hand, single pension-age individuals saw their income fall slightly as a result of the reforms (-0.3%), and only small gains have been seen for pensioner couples (0.5%).
In the report, we set the implemented policies against promises and declarations made by the principal parties during electoral campaigns and government goals declared in the Prime Ministers’ exposé’s.
Out of the main policies implemented by the 2005-07 government, only the PIT reform of 2009 has been introduced in a form declared in the 2005 PiS electoral program. Its introduction was, however, legislated for 2009 and fell therefore under the current term of office. The introduced reductions in the rates of the SSC, one of the most costly reforms, were not mentioned in the electoral pledges.
Moreover, the declared form of the CTC in the electoral program of PiS, was very different from the one introduced in 2007. The introduced program centered on the theme of a “solidarity package”, whereas the declared CTC was to be focused on low-income families. The introduced policy, about 9 times as expensive as the declared one, transferred resources to low-income families but was most generous to high earners who pay enough tax to take advantage of the generous maximum amounts of the credit. The generosity of the CTC makes it the most costly “tax expenditure” item in the Polish system of direct taxes, with a value of 0.4% of GDP (Finance Ministry, 2010).
In terms of the PO’s program and the Prime Minister Tusk’s exposé’s, the report analyzes the focus on further reduction of taxes. In the midst of the financial crisis, the current coalition oversaw the introduction of the 2009 PIT reduction but withdrew from implementing a 15% flat tax, one of its flagship policies prior to 2007. However, despite a reduction in the basic rate of tax from 19% to 18%, income taxes grew on average among low and middle-income households (1-6th decile) because of the freezing of the tax credits. The net effect of income tax policies, in the current term of office, has meant gains for higher income households, with a substantial reduction in income taxes for those in the top decile group (on average 23%).
In light of the growing level of public debt, the current government implemented a VAT reform that raised indirect taxes by about 0.3% of GDP. The combination of an increased basic rate, with a reduction of lower rates on main food items, produced a proportional distribution of the tax burden.
Overall, the tax record of the current government is mixed. The implemented reductions were legislated already prior to its arrival, and the net result of the packages implemented in recent years hangs importantly on the level of households’ income. On average, only the top three deciles of households have seen their tax burden fall.
Each of the coalitions have their excuses for failing to deliver the promised policies. For the 2005-07 coalition, it is the early dissolution of Parliament. The current government, led by the Civic Platform, had to maneuver through the difficult years of the financial crisis and an economic slowdown. At the same time, one could interpret the policies implemented in the first two years of the 2005-07 Parliament as an expression of policy priorities, whereas the policies implemented during the current Parliament, can be confronted with their previous declarations to examine which groups of society they have prioritized.
In Poland, household income has grown fast in recent years. On the one hand, due to growing wages and earnings, on the other, due to introduced packages of tax and benefit reforms. Despite the financial crisis, the Polish economy has so far performed relatively well.
The reforms implemented in the last two terms of office, offer however little guidance to the credibility of electoral declarations on socio-economic policy. Even though the Law and Justice party (PiS), the leading party of the 2005-2007 government, legislated one of its key promises while in office (the PIT 2009 reform), it also implemented substantial reforms which were either not originally in their electoral program, or which took a very different shape and benefited other segments of the population. Even if the current government withdrew from the promises of further tax reductions when faced with the challenges of the financial crisis, it oversaw the implementation of significant tax cuts legislated in the 5th term of Parliament. Overall, however, the implemented policies increased taxes of lower income households.
To conclude, our results suggest that if Polish voters’ decisions are to be guided by declarations in the area of socio-economic policy, they will face a tricky choice on the 9th of October.
Figure 1. Changes in disposable incomes of Polish households as a result of tax and benefit policies implemented between 2006 and 2011, by income deciles.
Source: CenEA, Myck et al. (2011). Notes: average monthly values per household in a given decile group.
References
- Finance Ministry (2010) “Tax Expenditures in Poland”, Polish Finance Ministry, Warsaw.
- Morawski, L., and Myck, M. (2010) “‘Klin’-ing up: Effects of Polish Tax Reforms on Those In and on those Out”, Labour Economics, 17(3), str.556-566.
- Myck, M., Morawski, L., Domitrz, A., Semeniuk, A. (2011) „Raport Przedwyborczy CenEA, część I. 2006-2011: kto zyskał, a kto stracił?” (CenEA’s pre-election report: 2006-2011 who gained and who lost? ), Microsimulation Report 01/11, Centre for Economic Analysis, Szczecin.
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