LAFFER TAXATION RATE: ESTIMATIONS FOR ROMANIA S CASE

Transcription

1 LAFFER TAXATION RATE: ESTIMATIONS FOR ROMANIA S CASE Elena PĂDUREAN Centre of Financial and Monetary Research Victor Slăvescu Romanian Academy Bucharest, Romania padureanelena@yahoo.com Andreea STOIAN Bucharest Academy of Economic Studies Bucharest, Romania andreea.stoian@fin.ase.ro Emilia CÂMPEANU Bucharest Academy of Economic Studies Bucharest, Romania emilia.campeanu@fin.ase.ro Abstract The relationship between taxation rate and tax revenues for the public budget has generated an important debate aiming that level of taxation rate that maximizes tax revenues collected for the public budget. Laffer curve involves the existence of a strong correlation between taxation rate and tax revenues. The aim of this paper is to estimate a Laffer taxation rate for Romania s case using annual data over the period The main findings highlight that a taxation rate higher than 28% could diminish tax revenue for the public budget, in addition, taxation rates were situated slightly on the prohibitive area of Laffer curve. Keywords: Laffer curve, taxation rate, tax evasion, implicit taxation rate JEL classification: E62 1. INTRODUCTION Taxes could be considered as something evil by the contributors, but necessary by governments, taking into account that they represent the most important financing source of public budget. Generally, contributors are paying those taxes, but when they exceed a particular amount, they could become a burden and could generate some undesired effects that could negatively affect the budget, too. An increase or a decrease of the excess burden induced by taxes could be related to the economic and social role played by state within an economy, and to its aim for financing government expenditures. The controversial debates on excessive state interference within economy went to a new approach, underlined by american economist, Arthur Laffer. Considering the representative contributor, Laffer proposed some guidelines for elaborating a good taxation policy that would have not harm

2 184 Elena PĂDUREAN, Andreea STOIAN, Emilia CÂMPEANU people welfare. Taxation rates have a great influence on contributors decisions related to income allocation between consumption and savings. According to Laffer s theory, high taxation rate changes contributor s behavior in terms of favoring leisure and lowering productivity, and increasing consumption and decreasing savings. According to supply-side theory, a progressive income tax will not reward the contributors willingness to work, but it will generate an increase of the labor cost compared to the leisure cost (in terms of net income that will not be earned anymore due to high taxes). Higher taxation rates for income diminish the work supply, and, consequently, the government tax revenue will be much lower. Much more, contributors use to allocate their income between consumption and savings. Income tax increases the cost of future consumption compared to the current consumption. The effects are an increase of current consumption and a decrease of savings and investments. Higher taxation rates will not encourage contributors to save or to invest as long as net income is diminished. Consequently, the contributors need to assure a proper income before increasing taxation goes to forms of tax evasion and black economy is increasing. The effects for the official economy are, as follows: reduced number of contributors; reduced tax based; inefficiency of macroeconomic policies. The aim of this paper is to estimate the highest taxation rate based on Laffer s theory that could prevent taxation to reach to the prohibitive area. The structure of this paper is as it follows. In next Section, it will be made a short description of Laffer s theory. Section 3 will consist of the methodology used to estimate the Laffer taxation rate for Romania s case. The last section will be dedicated to the main concluding remarks of this study. 2. THEORETICAL BACKGROUND OF LAFFER S THEORY AND LITERATURE REVIEW The relationship between taxation rate and tax revenues for the public budget has generated an important debate aiming that level of taxation rate that maximizes tax revenues collected for the public budget. Laffer curve is the result of the idea expressed by Laffer at the early 1980s that involves the existence of a strong correlation between taxation rate and tax revenues. The interval of variation lies between 0% and 100%; at that point, government collects no tax revenues due to the refuse of the taxpayers to work or avoid taxes. In this U curve, it can be identified two areas delimited by the taxation rate that maximizes tax revenues as presented in the figure below. Tax revenues (R) * R r E R 0 t Prohibitive area A B R r 1 R t 0 R 0 t 0 t 1 * t t 2 100% taxation Source: own representation Figure no. 1 Laffer Curve

3 Laffer Taxation Rate: Estimations for Romania s Case 185 The taxation rate that maximizes the tax revenues varies form country to country, especially due to the taxpayers reactions to different level of taxation. This taxation rate is important to all the governments, taking into consideration the need for more and more revenues to finance increasing budgetary expenditure. The initial Laffer curve involves only a taxation rate that maximizes tax revenues. But, there are authors that highlight the lack of a continuous curve or a maximum tax revenues for a particular taxation rate [Fullerton, 1982 ; Malcolmson, 1986] or the existence of many taxation rates that maximize tax revenues [Novales and Ruiz, 2002]. The different forms of Laffer curve could be the result of the governments reaction in order to sustain economic growth according to Mitchell (2002) who defined a so called Growth Laffer Curve (GLC). GLC is the results of the negative correlation between taxation rate and economic growth because higher taxes might: (i) assure more financial resources for public investment that may sustain economic growth; and (ii) affect the private capital accumulation and economic growth. The optimal taxation rate according to Laffer curve is difficult to be estimated for a group of countries. For instance, this taxation rate varies between 35% [Hsing, 1996], and 60% [Trabandt and Uhlig, 2006]. The taxation rate should be established in order to avoid tax evasion and the black economy. Feige, Edgar, and McGee (1983) showed that recent research on black economy suggests that the phenomenon has important implications for both macroeconomic policy and public finance. The authors focused on the public finance implications by developing a simple macro-model that makes it possible to derive a Laffer curve. This model reveals that the shape and position of the Laffer curve for Sweden depend upon the strength of supply-side effects, the progressivity of the tax system and the size of the unobserved economy. They also simulated the UK Laffer curve (1983). The dynamic Laffer curve was studied by Ireland (1994), (1995), Agell and Persson (2000), and Novales and Ruiz (2002). Ireland (1994) considered a single tax on output, and found a non-trivial range of feasible tax cuts. Agell and Persson (2000) analyzed the government budget balance within a simple model of endogenous growth by performing an empirical study of the transfer-adjusted taxation rates of the OECD countries to see which country has the highest potential for fiscal improvements. Novales and Ruiz (2002) analyzed the possible welfare gains from substituting debt for taxes in deficit management. Laffer curve had been studied in correlation with the situation of the delay retirement by Hairault, Langot, and Sopraseuth (2004). The authors investigated the situation that the taxation on continued work should be removed by implementing actuarially fair schemes and they proposed to give individuals only a fraction of the marginal actuarially fair incentives in the case of postponed retirement. This will make a tradeoff between giving enough incentives to make individuals actually delay retirement and giving little increase in pensions in order to help finance its expected deficit that can be captured by a Laffer curve using the French data. Laffer curve quantitatively was examined using a simple neoclassical growth model by by Trabandt and Uhlig (2006, 2010) for the US, EU-14 and individual European countries based on data during They showed that the relationship between taxation rates and tax revenues depends on the type of the taxation system (for instance, in a country it are used more taxes on capital, labor or consumption with a flat tax or a progressive taxation). Also, they revealed that US and the EU-14 area are located on the left side of their labor and capital tax Laffer curves, but the Denmark and Sweden are on the wrong side of the Laffer

4 186 Elena PĂDUREAN, Andreea STOIAN, Emilia CÂMPEANU curve for capital income taxation. EU-14 economy is much closer to the slippery slopes than the US. The slope of the Laffer curve in the EU-14 economy was much flatter than in the US which documents a much higher degree of distortions in the EU-14 area. Also, the authors highlighted that the US can increase tax revenues by 30% by raising labor taxes and 6% by raising capital income taxes, and for the EU-14 they find 8% and 1%. 3. ESTIMATING LAFFER TAXATION RATE: EMPIRICAL EVIDENCES FOR ROMANIA S CASE For Romania s case there are only few studies that considered the taxation issues based on Laffer s theory. In that sense, the studies conducted by Pădurean and Cataramă (2004) and Pădurean (2006) over the period showed that a simple projection of overall taxation rate and government revenues has not revealed a Laffer, but it could be observed a trend that indicates a positive relationship situated on the accepted zone of the Laffer curve. Also, the study highlighted the short periods when taxation rate situated on the prohibitive area. For instance, for the years 1992, 2001, and 2002 empirical evidence indicated a negative relationship between tax revenues and overall taxation rate, while for the year 1997, the correlation was negative. Moşteanu and Stoian (2005) proposed an alternative approach for Laffer taxation rate considering that the median could be a relevant proxy for that taxation rate, taking into account that the original Laffer s work, based on an graphical illustration, splits the taxation area on two even sub areas: a non-prohibitive one and a prohibitive one. The authors estimation for Laffer overall taxation rate indicated a value around 28% of GDP. Stoian (2008) estimated a Laffer taxation rate on annual data over the period and reached to the conclusion that a taxation rate higher than 31% will place taxation on the prohibitive area of Laffer curve. For an overall taxation rate of 31% of GDP it was recorder the largest amount of tax revenue for the public budget. One shortcoming of that study is represented by data used for estimation. Some of the data were projections and did not capture the situation after the financial crisis. In addition, Stoian (2009) found that over the period taxation rates were situated on non-prohibitive area of Laffer curve. The aim of this paper is to estimate Laffer taxation rate for Romania s case using annual data over for tax revenues as ratio to GDP, considered as proxy for overall taxation rate, and for tax revenues at constant price (1990=100). Table no. 1 Laffer taxation rate Year Overall taxation rate (%) Tax revenues at constant price (mil.ron)

5 Laffer Taxation Rate: Estimations for Romania s Case 187 Year Overall taxation rate (%) Tax revenues at constant price (mil.ron) Legend: Overall taxation rate: was estimated as ratio of tax revenues (social contributions included) to GDP and is a proxy for the taxation rates according to Laffer s theory. Tax revenues at constant price: was estimated based on tax revenue (social contributions included) and Consumer Price Index at constant price 1990=100. Source: Data were available from Ministry of Finance (tax revenues), National Institute of Statistics (for GDP and CPI). The Laffer taxation rate for Romani s case lies around 28% of GDP that generates the largest tax revenue for public budget. It is to some interest to see if taxation rates over the period considered were situated on non-prohibitive area of Laffer s curve. Based on the previous results, it was graphically illustrated for the case of Romania (see figure below): Source: own representation. Figure no. 2 Laffer Curve for Romania s case, Compared to the results obtained by Stoian (2009) for the period , adding the last three years moved taxation slightly to the prohibitive area of Laffer curve. That means that the much higher taxation goes, tax revenues for the public budget are decreasing. In addition, using the same methodology applied for a smaller sample over the period , it was estimated the Laffer taxation rate for consumption. The results are presented below:

6 188 Elena PĂDUREAN, Andreea STOIAN, Emilia CÂMPEANU Table no. 2 Comparing the results Anul Implicit tax rate on consumption (%) Value Added Tax at constant price (mil.ron) , , , , , , , , ,3 Legend: Implicit taxation rate on consumption (%): proxy for the taxation rate on consumption as average. Value Added Tax at constant price: was estimated based on VAT revenue and Consumer Price Index at constant price 1990=100. Source: Data were available from Ministry of Finance (VAT revenues), European Commission (implicit taxation rate of consumption). Laffer taxation rate on consumption lies around 17%, and is situated on the nonprohibitive area on Laffers curve, as shows the figure below: Source: own representation. Figure no. 3 Laffer taxation rate on consumption 4. CONCLUDING REMARKS Laffer s theory about the taxation rate could represent o benchmark in establishing that particular taxation rate that maximizes the tax revenue for the public budget and avoids tax evasion. The Laffer taxation rate for Romania s case estimated for annual data over the period lies around 28%, while taxation situates slightly on the prohibitive area of Laffer s curve. That finding implies that higher taxation rate than the Laffer one could diminish the tax revenue.

7 Laffer Taxation Rate: Estimations for Romania s Case 189 References [1] Agell, J., Persson, M., On the analytics of the dynamic Laffer curve, Working Paper , 1-26, [2] Feige, E.L., McGee, R.T., The Unobserved Economy and the UK Laffer Curve, Journal of Economics 85 (4), , [3] Fullerton, D., On the possibility of an inverse relationship between tax rates and government revenues, Journal of Public Economics 19, 3-22, [4] Hairault, J.O., Langot, F., Sopraseuth, T., A quantitative investigation of the Laffer curve on the continued work tax: The French case, EPEE and CEPREMAP Discussion Paper No. 1499, February, 1-37, [5] Hsing, Y., Estimating the Laffer Curve and Policy Implications, Journal of Socio-Economics 25, [6] Ireland, P.N., Supply-side economics and endogenous growth, Journal of Monetary Economics 33, , [7] Malcolmson, J.M., Some analytics of the Laffer curve, Journal of Public Economics 29, , [8] McGee, R.T., Feige, E.L., Sweden s Laffer Curve: Taxation and the Unobserved Economy, Economic Affairs, October, 1-6, [9] Mitchell, D., The correct way to measure the revenue impact of changes in tax rates, Impact-of-Changes-in-Tax-Rates, [10] Moşteanu, T, Stoian, A., Theoretical Considerations on Romanian Optimal Taxation System, published within the volume of International Economic Conference 25 Years of Higher Economic Education in Braşov, Braşov, [11] Novales, A., Ruiz, J., Dynamic Laffer curves, Journal of Economic Dynamics & Control 27, , [12] Pădurean, E., Impactul fiscalităţii asupra calităţii vieţii, unpublished PhD thesis, [13] Pădurean, E., Cataramă, D., Evaluarea curbei Laffer în România, Revista Finanţe Publice şi Contabilitate, nr.10, octombrie, [14] Stoian, A., Taxation Rate Estimation for Preventing Fiscal Evasion, publihed within the volume of the 1-st International Conference Financial Crime and Securitization of Banking Circuits in order to Prevent and Fight against Money Laundering, Sinaia, October, [15] Stoian, A., Dezechilibrele bugetului public în contextul economic actual, ASE Publishing House, Bucharest, [16] Trabandt, M., Uhlig, H., How Far Are We From The Slippery Slope? The Laffer Curve, SFB 649 Discussion Paper April, 1-69, [17] Trabandt, M., Uhlig, H., How far are we from the slippery slope? the Laffer curve revisited, European Central Bank Working Paper Series No / April, 2010.