Effects of Flat Tax Reforms in Western Europe on Equity and Efficiency

Abstract

The ‡at income tax has become increasingly popular recently, yet its implementation is limited to Eastern Europe. We analyse the distributional and e¢ ciency e¤ects of ‡at tax scenarios for Western European countries. Our simulations show that ‡at tax rates required to attain revenue neutrality with existing basic allowances improve labour supply incentives. However, they result in higher inequality and polarisation. Flat rates necessary to keep the inequality levels unchanged allow for some scope for ‡at taxes to increase both equity and e¢ ciency. Our analysis suggests that Mediterranean countries are more likely to bene…t from ‡at taxes. JEL Codes: C81, D31, H24Keywords: Flat tax reform, income distribution, work incentives, microsimulation This paper uses EUROMOD version C13. EUROMOD is continually being improved and updated and the results presented here represent the best available at the time of writing. Any remaining errors, results produced, interpretations or views presented are the authors'responsibility. EUROMOD relies on micro-data from twelve di¤erent sources for …fteen countries. Stephen Pudney and participants of ECINEQ, I-CUE and IMA conferences and seminars in Cologne, Essex and Mannheim and an anonymous referee for helpful comments and suggestions. We are indebted to all past and current members of the EUROMOD consortium for the construction and development of EUROMOD. However, any errors and the views expressed in this paper are the authors'responsibility. In particular, the paper does not represent the views of the institutions to which the authors are a¢ liated.

Tax Reform, Sector‐specific Labor Supply and Welfare Effects*

“…The distribution of CV demonstrated that the richest households benefited far more from the tax reform than the poorest household. Thus, there is a trade‐off between efficiency and equity as also found in Paulus and Peichl (2008). However, as shown above, most households gained from the (underfinanced) reform.…”

“…In 1994, a flat tax system was introduced in Estonia and since then a number of countries have followed suit. By now, there are altogether 22 countries worldwide with a flat tax system, of which half are in Eastern Europe, and proposals of introducing a flat income tax are being discussed in several Western European countries; see Paulus and Peichl (2008).…”

Is a flat tax reform feasible in a grown-up democracy of Western Europe? A simulation study for Germany

“…For the selection of our reform scenarios, we choose a systematic approach (see also, Paulus and Peichl 2007). Davies and Hoy (2002) demonstrate the existence of critical flat tax rates for revenue neutral tax reforms replacing a graduated rate tax with a flat rate tax (while keeping the tax base unchanged) such that compared to the graduated rate tax after-tax income inequality is:…”

The Benefits and Problems of Linking Micro and Macro Models — Evidence from a Flat Tax Analysis

“…In the literature, there are several simulation studies on efficiency and equity aspects of such (revenue neutral) flat income tax reforms. One focus of these studies is the impact on employment and growth using CGE models (see, e.g., Heer and Trede (2003) for Germany or Jacobs et al (2007) for the Netherlands), whereas a second group of studies focuses on the distributional effects using MS models (see, e.g., Aaberge et al (2000) for Italy, Norway and Sweden, Fuest et al (2008) for Germany and Paulus and Peichl (2008) for a cross country study of 10 EU countries). In summary, all previous studies support the existence of a trade-off between equity and efficiency, i.e.…”