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Modeling Fiscal Policy in the European Union


Janusz Kudla, Konrad Walczyk and Robert Kruszewski

The book discusses optimal fiscal policy for an internationally integrating economy when public borrowing is constrained. Various innovations have been introduced: the agglomeration effect, the fiscal solvency concept, the harmonization of capital income tax base with formula apportionment and transaction tax on financial transactions. Tax structure consists of taxes on labor, capital and consumption, and bonds – the study looks at equilibrium tax rates under international tax competition pressure, and estimates them econometrically. It also offers policy recommendations as a contribution to the discussion about the desired scope of fiscal integration in the European Union.
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Chapter 5: Fiscal policy recommendations


Chapter 5Fiscal policy recommendations

European corporate income tax rates are now one of the lowest in the world24 especially if considered by regions. It should be emphasized that in recent years the trend of declining capital tax rates is common and the most countries decided to lower them in last decade regardless of the impact of financial crisis. However, these cuts usually were followed by the tax base broadening. This process is especially evident in developed economies but debatable in developing economies. It is guessed that governments decrease corporate tax rates to attract or keep multinationals operating in the countries. For example in the case of United Kingdom the corporate tax rate dropped from 52% in 1980 to 28% in 2008 and finally 20% in 2015. Simultaneously government spending is not so easy to cut which exerts pressure on the financing with higher taxes on labor and consumption. The latter tax rate does not experience dramatic decline in last decade. The labor tax rates in the European countries decreased slightly after the outburst of the financial crisis and consumption tax rates even increased. The reason for this seems natural: as multinationals and capital are highly mobile and can easily move to other countries, the labor and consumption are perceived as relatively inelastic and prone to higher taxation. Therefore facing little danger of massive tax avoidance the increase of tax burden on labor or consumption is preferred from economic and political reasons. Especially current fiscal policy focus on the...

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