Fiscal Policy and Euro Jaromír Šindel ECES The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Fiscal Policy and Euro Jaromír Šindel ECES

Topics Fiscal Economic Policy Maastricht and SGP – dreams and facts The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Fiscal Economic Policy Time inconsistency, rules better than discretion, cyclical adjusted government balance,... Maastricht and SGP – dreams and facts Fiscal consolidation under Maastricht criteria, SGP reality, reform of SGP CEEC and Fiscal Policy, euro linkage Fiscal reforms, fiscal consolidation, implication for sustainable development and economic growth, Tax Competitiveness

Understand to Fiscal Policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague EFFICIENCY non-efficient tax system non-efficient spending Source: www.energystar.com, own layout.

Fiscal Economic Policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Structural and cyclical governmetn budget Automatic stabilizers automatically increase deficit during cyclical downturns by taxes based on incomes, especially when progressive or payments for unemployed workers (during downturns, automatic stabilizers moderate the business cycle) Gap of about 2% between cyclical and structural deficit during recessions shows effect of automatic stabilizers Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Fiscal Economic Policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Time inconsistency Inconsistency between short-time and long-time effect of fiscal policy. For example durign good times, government decreases taxes, more generally makes structural changes in fiscal policy. Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Fiscal Economic Policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Time inconsistency and election year Time inconsistency and the effect of structural changes in fiscal policy is stronger during election year. Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Ricardian Equivalence in the USA The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Savings in the USA, 1970-2003 (% GDP) Ricardian equivalence? Source: OECD Economic Studies No. 38, 2004/1

Sustainable Fiscal Policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague There is many measures of fiscal policy sustainability. We use the unchanging level of debt in GDP term. So: Because and , using derivation formula for change of d we get . In term of GDP and because we get . Our goal is , so the level of unchanged debt is . Then desired balance of fiscal budget is . Source: Obsfeld, Rogoff (2004)

Fiscal Policy in Europe Question of currency union Maastricht Treaty was not enough for Germany – Stability and Growth Pact was established. Troubles? If there are troubles with fiscal rules, how to cope with them?

Review of the OCA theory The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Benefits outweigh costs if … Markets are highly integrated Goods markets, Financial markets, Labor markets Shocks to currency union members are symmetrical (UK - oil) Labor markets are flexible Flexible fiscal policy for fiscal transfers (to cope with shocks) Question of OCA endogenity Convergence to OCA and higher flexibility follow integration process call for flexible and sustainable fiscal policy Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Why Rules in Eurozone? The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Free rider effect of countries with high debt and higher deficits of government balance, becouse there is common currency and interest rate. Fiscal imbalance in currency union can increase price level. Central bank have tighten monetary policy through higher common interest rate. And because you want to avoid increase in interest rate, there is call for fiscal rules.

Why Rules in Eurozone? The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Optimal Mix of Monetary and Fiscal Policy in Currency Union is not Feasible Optimum is sustainable fiscal policy and moderate monetary policy. But free rider problem with fiscal policy in monetary union. Some countries have unsustainable fiscal policy and tigher monetary policy is need. Optimal Mix of Monetary & Fiscal Policy is not Feasible due to Free Rider Problem Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Rules in Eurozone and Reality The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Debt and Deficit in Eurozone and EU Member Countries Source: Prof. E. Dolan, Lecture at VSE Prague, 2005.

Fiscal Policy - Changes, Reforms? The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Fiscal Policy and Tax Burden structure of tax burden, tax burden according to economic function Changes and Reforms Tax Competitiveness

Tax Burden The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Tax to GDP ratio in EU countries and the US and Japan (in %, ranked by 2003 level) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Structure of tax revenues by major type of taxes (2003, in % of total tax burdens) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to ec. function The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Taxes on labour – empl. and non-employed (pension and social benefits), consum. and capital - capital and business income and stocks (in % of GDP, 2003) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to ec. function The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Shares of tax revenues raised on labour (empl. and non-employed), consumption and capital (capital and business income and stocks) (in % of total taxation, 2003) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to ec. function The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Contribution of taxes on labour, capital and consumption (in % of GDP) to the changes in the total tax-to-GDP ratio (1995-2003, diff. in p.p. of GDP) Note:*LT: 2000-2003 Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to ec. function The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Development of implicit tax rates for the Member States (1995 - 2003, in %) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to Consumption The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Trend developments of ITRC in the old and new Member States (1995-2003, in %) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to Consumption The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Implicit tax rates on consumption in the EU (1995-2003 changes in the rate in p.p.) Note: LT, PL, SK: no data available Source: Eurostat. Structures of the taxation systems in the European Union

Tax Burden accord. to Labour The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Decomposition of the implicit tax rate on labour force in EU (2003, in %) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Competitiveness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Effective top statutory tax rate on corporate income (2005, in %) NOTE: Only the 'basic' (non targeted) top rate is presented here. Existing surcharges and averages of local taxes are included. The rate for Estonia refers only to distributed profits; as from 2000 the tax rate on retained earnings is zero. The rate for Italy includes 'IRAP'(rate 4.25%) a local tax levied on a tax base broader than corporate income. Source: Eurostat. Structures of the taxation systems in the European Union

Tax Competitiveness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Top statutory personal income tax rate (2005, in %) Note: Without surcharges - DK, FI, SE: state taxes plus municipality taxes Source: Eurostat. Structures of the taxation systems in the European Union

Tax Competitiveness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Develop. of effective top statutory tax rate on corporate income (1995-2005 in %) Source: Eurostat. Structures of the taxation systems in the European Union

Tax Competitiveness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Evolution by major type of taxes (1995-2003, differences in % points of GDP) Note: data for EE, CY and HU are not available for 1995. Source: Eurostat. Structures of the taxation systems in the European Union