ECON II

Committee on Economic and Monetary Affairs II

Robin Hood: Considering the increase of fortune of the world’s richest whilst other income levels stagnate, how should taxation systems in Europe be designed in order to reduce economic inequality and allow European countries to provide basic services to their population?

 

 

 

The Topic in Depth

written by Jakob Gutschlhofer (AT)

Since the 1980s, Europe has been facing a rise in income inequality. Between 1980 and 2017, the top 1% richest Europeans’ average income has grown twice as fast as that of the bottom 50%. Furthermore, in 2017 the top 10% earned more than 30% of all income. Even more pronounced are the differences when looking at wealth inequality where the top 10% own more than 50% of all household wealth. We thus observe more concentration of income and wealth in the last decades. Is that inherently bad? Not necessarily, some argue it is acceptable if there are sufficient (public) mechanisms in place to provide adequate means to the less well off and if everyone has a fair chance of reaching that top income bracket – but this is rarely the case. Some claim that the concentration of wealth and income is no issue and promote tax cuts for the rich, with the idea that money eventually will “trickle down” and benefit the less wealthy. Empirical evidence suggests that this only led to higher inequality with no positive effects on economic growth or unemployment. In addition, it may actually be harmful to economic growth[1] since the marginal propensity to consume[2] decreases with increasing income, that means, that for the very rich, additional income does not mean additional consumption.

 

Economic inequality goes hand in hand with inequality of opportunities. This relationship exists because often with higher inequality, family background plays a stronger role in children’s future income and reduces the impact of hard work. Unequally distributed economic and social resources cause more unequal education and job possibilities which in turn result in even more unequally distributed economic resources. Subsequently it pushes ideas such as the American Dream, that hard work is translated into high income and wealth, further away from reality.

 

Public policy can help mitigate this influence of family background through two channels. First, they can focus on redistribution of income to balance unequal economic resources. Second, they can provide public services, i.e. improving education since a university degree is required for many higher paid jobs, job market policies, and access to healthcare and medication. Failure to fulfil the latter basic human needs prevents an individual from performing at their full capacity and undermines the ability to exercise basic rights as adult citizens, threatening the functioning of democracies.

To finance its services and redistributive activities, a government needs to collect taxes. Everyone at some point pays taxes, whether they are value-added-tax, income tax (i.e. from wages and/or capital), inheritance tax or corporate tax. Where and how to set taxes and what transfers and services to provide with them is different in every country and rests on some understanding of “fairness”. However, current taxation models are often criticised for placing a proportionally bigger contribution burden over those who have less by mainly taxing income, taxing consumption proportionately and providing incentives for economic activity in the form of deductions or lower tax rates.

 

It is important to have a well-functioning tax system, not only in terms of tax revenues but also in fighting tax avoidance. While tax evasion[3] is illegal, tax avoidance[4] is legal. This is problematic since those individuals or corporations live in country A and enjoy all its public goods and services while their taxes are paid to country B. Consequently, since tax avoidance is usually limited to very rich individuals that would have paid a lot of taxes, even more taxes are proportionally paid by the bottom 90%.

 

In the EU, it is generally accepted that maximising social welfare should be the main aim of taxation and public spending. This includes improving public goods, especially in areas that tend towards market failure[5], such as education, healthcare and social protection. There is a big disparity between Member States because the EU does not have the decision-making power to change taxation laws, as this right is exclusive to the Member States. Equally, Member States only have to ensure that their budget is within the limits mentioned in the Stability and Growth Pact (SGP) and their taxes adhere to the harmonised standards set by all Member States.

 

[1] Economic growth is usually measured as the annual increase of the value of goods and services produced within a certain country (i.e. a country's Gross Domestic Product (GDP)).

[2] Marginal propensity to consume is how much you consume with each additional Euro you get (while the rest is saved).

[3] Tax evasion means deliberately avoiding paying tax debt (e.g. by misreporting income).

[4] Tax avoidance means reallocating money to somewhere with a lower tax rate.

[5] Market failure occurs where a market, when left to its own devices, results in resource allocations that do not maximise social welfare.

[6] Proportional taxes apply the same tax rate to all individuals regardless of income (for every Euro you pay x% taxes).

[7] Progressive taxes tax higher income more (e.g. for 10.000€ you pay 10% but for 20.000€ you pay 10% for the first 10.000 and 20% for the second half, thus 15% on average).

 

Topic Content

created by Rhiannon Smith (IE)

ECON II Podcast
00:00 / 13:20
 

Food for Thought

What does “fairness” mean to you? Do you believe that everyone earns what they deserve or do you believe that higher incomes should be taxed more to support people with fewer means?

What basic social services should be provided by Member States and which services should be provided by private companies?

What are (if any) “adequate means” that each person should be provided with to allow for more equal opportunities?

What are (if any) the benefits to a certain level of inequality?

In what areas should there be taxation (income, inheritance, corporate, consumption, financial transaction) and should it be proportional [6] or progressive [7]?

What should the EU’s future role in taxation be? What are potential advantages and disadvantages to the establishment of a fiscal union?

How can be done further against tax avoidance?

Useful Links

Videos

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Academic

  • Two books published by the OECD about economic inequality. All chapters are summarised at the beginning, making it easy to filter out the most important information:

  • This OECD publication provides a broader perspective on life and well-being in general, further provides sections and links to income and wealth inequality: OECD (2020). How’s Life? 2020.

 

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