Equity-efficiency implications of a European tax and transfer system

Abstract

This study simulates three income tax scenarios in a Mirrleesian setting for 24 EU countries using data from the 2014 Structure of Earnings Survey. In scenario 1, each country individually maximizes its own welfare (benchmark). In scenarios 2 and 3, total welfare in the EU is maximized over a common budget constraint. Unlike scenario 2, the social planner of scenario 3 differentiates taxes by country of residence. If a common tax and transfer system were implemented in the EU, countries with a relatively higher mean wage rate—particularly those in Western and some of the Northern European countries—would transfer resources to the others. Scenario 2 implies increased labor distortions for almost all countries and, hence, leads to a contraction in total output. Scenario 3 produces higher (lower) marginal taxes for high- (low-) mean countries compared to the benchmark. The change in total output depends on the income effects on labor supply. Overall, total welfare is higher for the scenarios involving a European tax and transfer system despite more than two thirds of all the agents becoming worse off relative to the benchmark. A politically more feasible integrated tax system improves the well-being of almost half of all the EU but considerably reduces the aggregate welfare benefits.

The Equity-Efficiency Trade-Off in the Presence of Distorting Taxation

“…• For further discussion of the equity-efficiency controversy, see for example Dalamagas et al (2022), Goulder et al (2019), Stantcheva (2020), Piketty and Saez (2013), Gürer (2021), Colas and Hutchinson (2021), Jacobs et al (2010), Gerritsen (2017), McKenzie (2021, Muinelo-Gallo and Lescano (2022), Magnani and Piccoli (2020).…”