1. Tax and social policy reform: Some lessons from new EU member states Ben Slay Senior economist UNDP Bureau for Europe and CIS 12 January 2000

2. Presentation topics n Tax reform and: –EU accession –Links to social policy, labour market reform n Initial lessons from 5 new member states that have: –Combined these reforms –Introduced flat taxes n Tentative conclusions: –Reforms have been successful –Useful experience for Turkey?

3. GDP in the EU NMS: How does Turkey compare? GDP in the EU NMS: How does Turkey compare? 2008 per-capita GDP (in PPS terms, EU average = 100), Eurostat data

4. Which countries? Estonia

5. What’s a flat tax? n Key feature: A single, proportionate tax rate n Other common features: –Fewer exemptions, deductions –Same rate for different taxes (PIT, CIT, VAT... ) –Attempt to align de jure tax systems with de facto capacity

6. Are flat taxes “fair”? n “It depends”—differing normative views n Literature says: –“Vertical equity” may be violated... –... But a high taxable income threshold can protect low-income taxpayers... –... And better compliance increases de facto progressivity n For a flat tax to work, taxpayers have to believe that rates on “legalised” incomes won’t be raised

7. “Flat tax” countries examined here Country Year adopted PIT rates CIT rates 2007Pre-reform2007Pre-reform Estonia199422% 16% - 33% 22%35% Lithuania199427% 18% - 33% 18%29% Latvia199725% 10%, 25% 15%25% Slovakia200419% 10% - 38% 19%25% Romania200516% 18% - 40% 16%25% Source: Business Eastern Europe, 22 January 2008, pp. 1-2.

8. Social policy reform n Restructure social service provision to improve quality, reflect trends in: –Demographics –Labour markets –State budgets n Social protection: –Reduce benefit dependency n End ”poverty traps” n “Make work pay” –Better target social assistance

9. Labour market n Labour code reform, to: –Make redundancies easier, to strengthen employer hiring incentives –Promote “non-standard” employment –Support new “public private partnerships” n “Welfare to work” programmes n Allow private job placement firms to compete with state employment offices n Get links to social, tax policies right –Goal: Reduce high marginal tax rates for low- income workers (“unemployment traps”)

10. Performance criteria for assessing reforms’ impact n Output (GDP) n Labour market: –Employment –Unemployment n Fiscal trends n Poverty and inequality

11. Performance: Good on GDP growth... Average annual GDP growth 2005-2008 % points above NMS average

12. ... And on employment Average annual employment growth 2005-2007 % point difference from NMS average

13. Reforms have not upset fiscal balance... General government budget (% of GDP), annual averages for 2002-2007 period. Eurostat data.

14. ... Or produced large public debts General government debt, % of GDP, 2007

15. Unemployment rates fall, both overall... Average annual unemployment rates % deviation from average NMS decline

16. ... And for youth unemployment Average annual youth unemployment rates% deviation from average NMS decline

17. “Unemployment trap” revisited n Example: Family of four –2 parents, two children –1 parent works, earns 33% of average wage n Benefit eligibility: –Unemployment benefits (for other parent) –Child allowance (for children in low- income families) –Supplement for low-income families

18. Question: Do benefits fall as earned income rises? Answer: Yes, a lot Effective tax rate on additional earned income, in form of lost benefits Q: Why take the work? (Unemployment trap)

19. “Unemployment trap”: Getting weaker? Marginal tax rate on income earned by worker supporting family of 4 at 33% of national wage

20. Absolute poverty rates correlate with GDP 2005 World Bank, UNDP data, based on PPP exchange rates, $4.30/day poverty threshold

21. Relative poverty: Do Ginis point to problems? Gini coefficients, World Bank data

22. Conclusions n Tax reform: Not only about growth –It’s also about poverty reduction, social inclusion n Key questions—Links between taxes and: –Labour, social policy –Joint inclusion memorandum (in accession negotiations) n When “done right”, flat tax reform can: –Reduce poverty –Support social solidarity –Perhaps at the cost of higher inequality