Agency leads to distinctive choices: the case of tax systems in ‘normal’ European nation-states

By stewartb – a long read

As we in Scotland spectate, Tory hopefuls to be our next Prime Minister are putting tax policy front and centre in their campaigns. I fear the fall-out for Scotland’s public finances from what the Tory Party eventually decides is best for us.

I suspect that too many in Scotland – perhaps especially those hesitant about independence – fail to appreciate fully the options that having the agency of an independent nation-states brings. This is especially important when making big choices about what is best for national circumstances. I’m also conscious of claims of those opposed to EU membership that an independent Scotland within the EU would not be independent at all.

This post illustrates the diversity of choices made by normal independent nation-states, including those within the EU, in the particular domain of taxation. It draws heavily on a EUROSTAT paper on tax revenues within EU and other European countries.

Source: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Tax_revenue_statistics#Tax_revenue-to-GDP_ratio:_Denmark.2C_France_and_Belgium_show_the_highest_ratios

Changes in tax revenue

The graph below shows changes in total tax revenue and social contributions as a percentage of GDP within two groupings of European countries since 1995 – EU members and Euro area (EA) countries.

Source: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=File:Total_revenue_from_taxes_and_social_contributions,_EU-27_and_EA-19,%25_of_GDP,_1995-2020.png

As the EUROSTAT paper explains, there are many reasons why government tax revenue varies from year to year – changes in economic activity (affecting levels of employment, sales of goods and services etc.); changes in tax legislation (affecting tax rates, the tax base, thresholds, exemptions, etc.); changes in the level of GDP which in turn alters the tax to GDP ratio.

The financial crisis from 2008 – together with fiscal policy measures adopted by countries to stimulate the economy – impacted strongly on the changing level and composition of tax revenue between 2009-2016. The more recent recovery in tax revenue in most EU Member States is at least partly attributed to active revenue-raising measures, for example increases in the VAT rate, and the introduction of new taxes, such as bank and property taxes. Governments of ‘normal’ countries are able to take such compensatory actions to meet national needs and wants.

In 2020, absolute tax revenue decreased for only the second time since 1995 due to the economic effects of the COVID-19 pandemic. All major tax categories showed a decrease at the level of the EU, but different reactions of the main tax categories can be observed in different nation-states.

Total tax variability at country level

In 2020, tax revenue (including social contributions) in the EU amounted to 41.3% of GDP, and accounted for 89.3% of total government revenue. At the country level, the proportions were highly variable (see graph below). To emphasise: different countries, despite all being bound by their common membership of the EU or the Euro area, exhibit widely different positions on total tax revenue relative to national GDP.

The ratio of 2020 tax revenue to GDP was highest in Denmark (47.6% of GDP), France (47.5% of GDP) and Belgium (46.2% of GDP), followed by Sweden (43.4% of GDP), Italy (43.0% of GDP), Austria (42.6% of GDP) and Finland (42.2% of GDP). The lowest shares were recorded in Ireland (20.8% of GDP), Romania (27.2% of GDP), Malta (30.4% of GDP), Bulgaria (30.6% of GDP), Lithuania (31.2% of GDP) and Latvia (32.0% of GDP).

So here is a wide range of countries each with the capability and capacity to utilise the agency of ‘normal’ independent status to implement distinctive tax policies. Despite the wide variability in the outcomes of their decisions, are these countries still functioning, still sustainable, democratic European nation-states? Of course they are!

Variability by tax category

Revenue from taxes and social contributions can be grouped into three main categories: (i) indirect taxes defined as taxes linked e.g. to production and imports (such as VAT); (ii) direct taxes on income (personal and business) and wealth; and (iii) net social contributions.

The figure below shows how at the aggregate level of EU countries, the revenue from different categories as a percentage of GDP varies in proportion and changes over time.

Differing national tax structures result in considerable variation in the relative importance of indirect taxes, direct taxes and net social contributions from country to country in terms of the tax revenue they are used to generate. This is illustrated in the graph below which shows the situation in 2019/20.

An explanation of terms can be found in the referenced EUROSTAT document. My point is the simple one: different independent nation-states all within the EU or the Euro area use their agency to make substantially different choices over fiscal policies to suit national circumstances.

In 2020, the highest ratio of taxes on production and imports relative to GDP was recorded in Sweden (21.8%), in line with the relatively high overall level of taxation in that country. The lowest ratios of these indirect taxes were recorded for Ireland (6.6%), Romania and Germany (both 10.5%), Malta (10.9%), Luxembourg (11.2%), Spain (11.5%), Czechia (11.6%), Lithuania (11.8%) as well as non-EU state, Switzerland (5.5%), with Ireland and Switzerland having a low overall level of taxation.

The highest level of taxes on income, wealth etc. is in Denmark, which raised c. 30.9% of GDP from these taxes in 2020. This comparatively high ratio is due to most social benefits being financed via taxes on income in Denmark. As a consequence, the Danish figures for net social contributions are very low relative to other countries.  The next highest figures are for Sweden, Finland, Luxembourg and Belgium, which raise 18.2%, 16.0%, 15.9% and 15.8% of GDP respectively from current taxes on income, wealth, etc. At the low end of the scale in 2020, Romania (4.7% of GDP), Bulgaria (5.9% of GDP) and Croatia (6.5% of GDP) had relatively small revenue from these taxes and also show a generally low tax-to-GDP ratio.

These are big differences between European countries. Given the spread of choice in evidence, is the present UK tax system optimal for Scotland’s economy? Will the changes coming downtrack from the next Tory PM – designed to be attractive to Tory ‘values’ – be aligned with Scotland’s needs and wants?

It is at least conceivable, to say the very least, that Scotland – with c. 5.5 million population, distinctive economic assets, distinctive export vs. import performance – would benefit from different fiscal choices from those being made in Westminster for a UK economy dominated by England’s c. 55 million population, by London’s financial services industry and by the economy of South East England.

Competitiveness of tax systems

The International Tax Foundation (ITF), based in Washington DC, analyses tax systems in OECD member countries: the latest was published in 2021.

Source: Bunn and Asen (2021) International Tax Competitiveness Index 2021. International Tax Foundation (https://files.taxfoundation.org/20211014170634/International-Tax-Competitiveness-Index-2021.pdf  )

Its International Tax Competitiveness Index (ITCI), based on a basket of metrics, seeks to measure ‘the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality.’ It defines tax neutrality: ‘a neutral tax code is simply one that seeks to raise the most revenue with the fewest economic distortions. This means that it doesn’t favor consumption over saving, as happens with investment taxes and wealth taxes. It also means few or no targeted tax breaks for specific activities carried out by businesses or individuals.’

The purpose of using this reference to the ITF is NOT to endorse its judgement of tax systems and how they should be constructed. Rather it is re-enforce the point that different Western, democratic nation-states –  including smaller ones – demonstrate fiscal diversity. They have the power and capability to make and sustain distinctive choices.

Interestingly, the ITF report states: ‘For the eighth year in a row, Estonia has the best tax code in the OECD. Its top score is driven by four positive features of its tax system. First, it has a 20 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income. Third, its property tax applies only to the value of land, rather than to the value of real property or capital. Finally, it has a territorial tax system that exempts 100 percent of foreign profits earned by domestic corporations from domestic taxation, with few restrictions.’  Latvia, which recently adopted the Estonian system for corporate taxation, New Zealand and Switzerland are also ranked highly, favourably by the ITF.

Of the 37 countries listed in the ITCI, the UK is as low as 22nd when it comes to competitiveness and neutrality, two places less favourable on these measures than Ireland. Of other, smaller EU countries Sweden, Finland and Denmark are ranked 8th, 15th and 28th respectively.

Who’s levying the taxes? Another variable concerns where within independent nation-states the authority to levy taxes and social contributions lie. The chart below from EUROSTAT again reveals how different countries make quite different choices. (‘State governments’ are only present in Belgium, Germany, Spain, Austria and Switzerland.)

The UK tax system

The OECD provides a profile of the UK tax system in comparison to other member countries.

Source: ‘Revenue Statistics 2021 – the United Kingdom’ https://www.oecd.org/tax/tax-policy/revenue-statistics-united-kingdom.pdf

Since the year 2000, the tax-to-GDP ratio in the UK has changed little. During that period the highest tax-to-GDP ratio was 32.9% in 2007, 2011, 2017 and 2018, with the lowest being 31.0% in 2009.

The tax to GDP ratios for OECD members in 2020 are plotted below. The UK ranked 23rd out of 38 OECD countries on this measure. In 2020, it had a tax-to-GDP ratio of 32.8% compared with the OECD countries on this measure. In 2020, it had a tax-to-GDP ratio of 32.8% compared with the OECD average of 33.5%.

Is Scotland more like Denmark, or Norway, or Ireland than an England- or a South East England-dominated UK economy?

The OECD also profiles the UK tax system in terms of tax categories (see chart below). Relative to the OECD average, the tax structure in the United Kingdom is characterised by:

• higher revenues from taxes on personal income, profits & gains; property taxes; and value-added taxes.
• lower proportion of revenues from taxes on corporate income & gains; social security contributions; and goods & services taxes (excluding VAT/Goods and Services Tax).

End note – for interest

‘Normality’ is ability to make different choices

Despite commonalities of EU, even Euro area, membership the governments of ‘normal’ democratic independent nation-states make quite different decisions and achieve different outcomes with regard to their tax systems.  No doubt each is making economic (and political) decisions deemed to be optimal for their country and its citizens. In short, AGENCY not only enables but results in quite different choices.  

Who should decide on what is optimal for a tax system for Scotland? Why is the answer still not obvious!

End note – for interest