Fiscal convergence in European Union

Transcription

1 Fiscal convergence in European Union Abstract: The fiscal convergence of European Union countries has become a subject of interest in the last period. Fiscal policy is an important part of EU policies as member states must abide by the competition rule within the single market. At the same time, countries must comply with the convergence criteria set up in the Treaty of Maastricht, which establishes limits for public debt and deficit, the Stability and Growth Pact and the Fiscal Pact. In order to achieve tax harmonization, national tax systems must be coordinated and changed accordingly. The extent of fiscal harmonization between EU member states was intensely debated. At present there is no single taxation policy at European level, each member state pursuing its own fiscal policy. Therefore, differences in the tax regimes and tax rates have led to tax competition on the common market, making necessary to implement effective tax coordination within the European Union. We will also analyze the convergence of the fiscal systems of EU countries applying the indicators most utilized in the literature for assessing the degree of convergence, respectively σ- convergence and β-convergence. We will also use the time-series analysis in order to study the fiscal convergence data. Our results show the need to design additional policies at EU level in order to improve fiscal performance. Keywords: fiscal policy, fiscal convergence, tax competition, tax harmonization Introduction The topic of convergence derives its importance from the fact that the convergence between EU member states can contribute to an increase of European Union competitiveness at world scale. At the same time, achieving a higher degree of convergence can lead to more internal cohesion between European countries. Tax convergence was considered an objective of the fiscal policy within the European Union for a long time and was subject of many studies. The fiscal convergence of European Union countries is assessed in comparison with the criteria of convergence established within the Treaty of Maastricht, afterwards complemented by the rules from the Stability and Growth Pact. The evaluation of fiscal convergence has as purpose the consolidation of the process of European unification and uniformization of monetary and fiscal systems at the level of EU countries.

2 The convergence of the fiscal systems from the standpoint of the policies of fiscal harmonization and tax competition can be studied from two perspectives: the convergence of the tax burden (total tax revenue as a percentage of GDP) and the convergence of the tax structure (the components of tax structure as a percentage of total tax revenue). The issues of tax coordination as a tool for avoiding distinct policies and tax harmonization which means an equalization of effective tax rates have been discussed from the very beginning of European integration. European tax systems are not uniform due to differences of economic structures and national fiscal autonomy. In the analysis of fiscal convergence there have been used several measures of convergence, like absolute or conditional beta-convergence, sigma-convergence, and stochastic convergence. Absolute or conditional beta-convergence and sigma-convergence refer to the analysis of the issue of catching up of the new EU members to the main EU members, while stochastic convergence is concentrated on synchronization of shocks and cross-sectional units moving together in time. Definitions of convergence The literature on convergence from a time series perspective (Carlino and Mills, 1993; Quah, 1993; Bernard and Durlauf, 1995; Evans and Karras, 1996; Li and Papell, 1999) has given rise to three concepts long run, deterministic and stochastic convergence or catching-up. Long run or absolute convergence requires the equality of the long run predictions of the fiscal magnitudes, so the difference between the country and the benchmark must be a zero-mean stationary series. The strength of this restriction has meant that this kind of convergence, called asymptotically perfect convergence by Hobijn and Franses (2000), is not frequently confirmed. Stochastic convergence or catching-up version refers to when the difference is stationary around a trend. Carlino and Mills (1993) point out that a condition of β-convergence must be confirmed as well to ensure the strengthening of the difference. Thus, stochastic convergence is attained when both preliminary stochastic convergence and β-convergence are verified. Li and Papell (1999) propose deterministic convergence as an intermediate concept between the previous two when the difference is stationary around a non-zero level, which is the same idea behind the asymptotically relative convergence of Hobijn and Franses (2000). Nevertheless, this is a weak concept of convergence as it permits important, though constant, differences between the series. The issue of convergence is connected to economic growth. There are several factors which influence economic growth in certain countries and thus explain the differences in real income per capita. The analyses of convergence have started with the study of absolute convergence, which can be defined as a process in which economies with lower capital per worker grow more quickly than economies with higher capital per worker. But empirical observations often show

3 the contrary of these observations, because the economies with high capital per worker often achieve high GDP growth per worker. As a result it was established a condition of homogeneity: if we measure convergence among homogeneous sample with the same institutional parameters, then we speak about conditional convergence. OECD countries represent a typical sample in order to measure conditional convergence. Absolute or conditional convergence can be verified by β-convergence and σ-convergence. An application of these approaches depends on the methodological framework for research of listed types of convergence. The β-convergence, which can be found in studies of Furceri and Karras (2008), Michelacci and Zaffaroni (2000) or Pfaffermayr (2009), is based on neoclassical theory of economic growth. According to this theory, countries which are poorer in the beginning show more dynamic growth. GDP growth per capita is negatively dependent on initial economic level and β-convergence is characterized by a negative slope of a linear function. The σ-convergence concept is applied by for example Dalgaard and Vastrup (2001), Lucke (2008) or Miller and Upadhyay (2002) and it is also based on the neoclassical theory of economic growth. According to sigma convergence, all countries converge towards the same level of advancement and σ-convergence is defined as lowering of variance of real GDP per capita logarithm among economies in time. Literature review The issue of tax convergence was considered to be an objective of the European Union and there are several authors who studied this topic. Within a study published in 2006 on fiscal convergence, Delgado (2006) utilized as a method of analysis sigma and beta techniques and gamma convergence methods. The results of the study show the existence of convergence of the tax structure and fiscal pressure during In this paper the convergence of tax policy in EU-15 is examined using a time series approach. The convergence of the main components of tax revenue is analyzed taking into account the main components: income and profits, social security contributions, property, general taxes on goods and services, taxes on specific goods and services. The reference taken for the analysis is Germany, the United Kingdom and the European average and there are used two complementary perspectives: the tax burden and the tax structure. Using unit roots and stationarity tests with a structural change, and taking into consideration also β-convergence, the results show little evidence of tax convergence in EU-15 countries. Esteve, Sosvilla-Rivero and Tamarit (2000) examined the degree of convergence in fiscal pressure registered in EU during , using data from OECD. Both the traditional crosssectional convergence indicators and the time series analysis of the long-run properties of the data set are examined. The results of the study show that when using traditional convergence indicators, there has been certain convergence in fiscal pressure during , while significant divergence was found for

4 The paper simulated the effects produced on growth rates of the fiscal policy changes in EU. The individual country growth effects of actual changes in taxes, expenditures and deficits are plausible at around 0.3 to +0.3 of a percentage point per annum. The differences between countries were due to the extent to which distortionary taxes or deficits were used to fund public spending increases. One implication of these results is that changes in the overall share of taxes or spending in GDP or the annual budget surplus/deficit do not indicate precisely whether the growth effects of fiscal policy are likely to be positive or negative. A study made by Fatas and Mihov (2003) analyzed how discretionary fiscal policy affects output volatility and the rate of economic growth, using data for 51 countries. The results of the study show the existence of several empirical regularities, like the fact that governments that use often fiscal policy make their economies volatile. Fiscal policy use is explained to a large extent by the presence of political constraints and other political and institutional variables. The volatility of output induced by discretionary fiscal policy lowers economic growth by 0.6 percentage points for every percentage point increase in volatility. Rules-based fiscal policy identified by the degree of automatic stabilizers in the economy helps to stabilize business cycles. The conclusions of this paper argue in favor of imposing institutional restrictions on governments as a way of reducing output volatility and increasing the rate of economic growth. Another paper published by Blot and Serranito (2004) shows that since the Maastricht Treaty the convergence of fiscal policies has been a main element of the monetary unification. The convergence was first imposed with the help of fiscal criteria about the values of debt and deficit. All these institutional arrangements were mainly designed to favor convergence in order to strengthen the credibility of the Central Bank and to internalise negative international spillovers. An important reduction of the fiscal deficits appeared after the EU countries entered the monetary union. But this decrease of current deficits cannot be interpreted as a global converging trend if primary deficits or cyclically adjusted deficits evolve quite differently. The paper uses unit root tests to examine the convergence of fiscal policies among EMU members. Thus it is possible to assess if the convergence is accepted and if it is due to institutional factors (such as the Maastricht Treaty) or to structural factors. De Bandt and Mongelli (2000) examine whether economic, financial and monetary integration on the one hand, and institutional factors on the other, may have led to gradual convergence in key fiscal variables across the euro area over the recent period, bringing fiscal positions closer together. The Maastricht convergence criteria have facilitated this process, but the paper investigates whether the structural factors have been a feature of European integration starting already in the 1970s. The alternative scenario is that the euro zone is still characterised by largely idiosyncratic national fiscal policies. Using annual data for for government net lending, and total current revenue and expenditure to uncover common trends, as measures of fiscal convergence, the authors use crosscorrelation, dispersion and cointegration tests. The results of the study are that in the euro area countries cross-correlation has increased steadily over the sample period and that fiscal dispersion has been declining at a sustained pace among all countries in the sample. There is evidence of cointegration across the euro area for several

5 countries on the basis of total current revenue, and also for total current expenditure. However, when the series are corrected for the business cycle, cointegration is only accepted for net lending. There is clearly common fiscal cycles for net lending across the euro area that do not only express common business cycles. However, while countries have followed more similar policies in the 1990s in particular during the run-up to EMU, the timing of fiscal adjustment differed across countries. In addition, idiosyncratic components still contribute to a significant share of the variability of individual countries. In a study published in 2006, Onorante (2006) shows that the monetary integration of the countries which accede to EU will proceed in several distinct steps, starting with membership in the European Union (EU), followed by participation in the so-called Exchange Rate Mechanism (ERM) II and ultimately entry into the euro area. In this paper the author discusses whether a reduction of public deficits, such as imposed by the Maastricht fiscal criteria, plays an important role towards the adoption of the euro. This question is approached by examining the interaction of monetary, fiscal and wage policies and their effects on prices in a monetary union hit by economic shocks. As for acceding countries, the conclusion is that the process of deficit reduction should be finalized before entry, according to the Maastricht criteria. Konceda, Kutan and Yigit (2008) prepared a study about fiscal convergence in European Union and they focused their research on 10 countries which adhered to EU in They use in the study the method of beta-convergence, and the results of the study are that monetary unions do not produce fiscal convergence for the members of these monetary unions automatically, due to the poor fiscal performance across all EU countries. Methodology The methodology for the study of β-convergence is based on the analysis of Baumol (1986) of real convergence between economies, which represents the conventional approach of convergence analysis. Through graphical projection of statistical data and through observed dependencies Baumol has constructed the growth equation: where T is the end of time period, yt is real GDP per worker at the end of time period, t0 is the initial time period, is real GDP per worker at the beginning of time period, β1 is the intercept, β2 slope parameter, ε is statistical error term and i is index marking each country. For this paper we used the modified equation of Baumol adapted by

6 where α is level constant. The concept of σ-convergence also comes from neoclassical growth theory. The σ-convergence is defined as lowering of variance of real GDP per capita logarithm among economies in time. Sigma convergence is then described as catching up effect. If the variance of real GDP per capita logarithm is denoted as then σ-convergence among t and t+1 period means: in a group of countries in time t We will use for our analysis the countries members of European Union in order to analyze fiscal convergence using the techniques of sigma and beta convergence. The data used in our study refer to the structure of the fiscal system and the fiscal pressure during The data was extracted from OECD Revenue Statistics Comparative Tables Database and from Eurostat, using the information provided in the study Taxation Trends in the European Union. For the sigma-convergence based analysis, we used information regarding fiscal pressure, as the percentage of revenue from taxation in GDP. We obtained the results based on the following equation for the coefficient of variation (CV): where n is the number of objects (member states), t represents the year, i represents each of the member states considered in turn and y is the total fiscal pressure. The first part of our research consists of an analysis of sigma-convergence for 28 member states. For the classical approach, the results we obtained are represented in Figure 1.

7 Figure 1: convergence in the EU-28 Total guvernment revenue, as percentage of GDP, ,2 0,18 0,16 0,14 0,12 0,1 0,08 0,06 0,04 0, Source: Authors own calculations Convergence tendencies for the member states can be observed until From 2008, the financial crisis and the fiscal measures some member states were forced to take in order to counteract its negative effects, have led to fiscal divergence in the EU. However, starting with 2009, the coefficient of variation (CV) is almost constant, which might suggest that it will start to decrease again as soon as the effects of the crisis are no longer visible. The data for analyzing the real convergence among EU countries comprise data for each member state of European Union from Eurostat database. For the economies studied we used annual time series of total tax revenue as a percentage from GDP. The goal is to find out whether among EU economies is the convergence process present or there are more divergence tendencies. Mathematically, the estimate of a regression model of crosssection data for the EU countries can be written as follows: where:

8 log Tax revenue logarithm of tax revenue as a percentage in GDP, α constant level, β slope parameter, εi random component, i index indicating the country (total of 28 countries monitored in the reference period ) 0,T index indicating the time (0 = 2001, T = 2012). Parameters of linear regression model of crosssection data are estimated using least-squares method (OLS). The model will be verified statistically at 5% significance level. Statistical significance of the model was tested using the F-test. Individual model parameters were tested by the t-test. Model as a whole is statistically significant at 5% level of significance. The value of the correlation coefficient R indicates that total tax revenue in each country is 81% dependent on the development of explanatory variable, ie initial levels of GDP per capita. Table 1: Summary of Beta Convergence Model R R square Sig. F change Durbin- Watson 0,810 0, * 1,702 Note: * 5% significance level Source: authors calculations Conclusions The results of our research point to the conclusion that the existence of convergence tendencies among the member states of the European Union in the area of taxation cannot be denied. Our conclusions are similar to those of previous studies on the matter, even if they were done using other research methods or considering different time periods. The results of the sigma-convergence analysis show clear convergence tendencies before 2008, regardless of the calculus approach used. The effects of the worldwide economic crisis have led to pronounced divergent tendencies in taxation throughout the EU in 2008 and The beta-convergence approach is verified by econometric modelling techniques, namely with the use of cross-sectional linear regression analysis. The next focus is given on the examining of the sigma- convergence which is tested by standard deviation of real GDP per capita. The aim is to verify the hypothesis that the approach of beta-convergence and the concept of sigmaconvergence lead to a different result for the EU member states in the period

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