Daily Management Review

New IMF study recommends expanding tax collection, rather than increasing tax rates


Most of the tax reforms in OECD countries, regardless of their schemes, have shown a positive effect on macroeconomic stabilization in the last 40 years. Expansion of the direct and indirect taxes bases and increase in their rates improved resilience of economies to shocks, the IMF study says. But reforms aimed at expanding the tax base show this effect statistically more reliable and stronger and are more benign: they don’t slow down the short-term growth of the economy much and even accelerate it in the medium term.

Images_of_Money via flickr
Images_of_Money via flickr
The tax policies of developed countries over the past 40 years have tended to substantially support macroeconomic stabilization and medium-term economic growth, smoothing out fluctuations in production and employment, as well as reducing macroeconomic uncertainty and creating a favorable environment for the accumulation of physical and human capital, the IMF working report says. The purpose of the study was to find answers to questions about what and how do tax reforms mitigate the transfer of macroeconomic shocks to disposable income and consumption.

For example, tax revenues are stronger, and disposable income and consumption are less dependent on production, that is, reforms that expand the base and/or increase rates will automatically contribute to smoothing shocks. Analysts relied on data on major tax reforms that change the rate or base of personal income tax, income tax and VAT in 13 OECD countries from 1980 to 2016. To minimize the impact on business cycle assessments, only reforms that were not directly aimed at stabilizing production were taken into account. In total, the authors identified 77 such reforms, about 70% of which were due to changes in direct taxes. In this group of reforms, the changes in the tax base and rates turned out to be approximately equally divided (23 and 26, respectively), while VAT reforms were mainly reduced to a change in the rate (20 vs. 8). On average, personal income tax and income tax rates significantly decreased until 2007, while the VAT rate slightly increased. At that, the average ratio of fees to GDP did not change much: the reduction in rates and the expansion of the tax base compensated each other, the study authors state.

IMF analysts have concluded that reforms that broaden the tax base better smooth out external shocks than those at which rates are rising, and this effect itself can be more accurately assessed. Tax reforms, which increase tax elasticity, fineness of setting the tax scale (for progressive taxes) and quality of administration have the strongest influence on fiscal stabilization, ultimately stabilizing income and consumption. At the same time, the impact of tax policy itself is symmetrical: reforms that increase and decrease the rate or base have a comparable effect, which, in particular, explains why traditional instruments of fiscal policy change little over time. However, reforms that expand the tax base for direct and indirect taxes not only generate substantial tax revenues and have a smaller negative impact on short-term growth, but also contribute to macroeconomic stabilization and enhanced growth in the medium term.

source: imf.org