How to finance social
protection?
I. What is social protection?
II. Empirical view
III. Theoritical view
Nowadays, the challenge is still to have a
high level of social protection but also to
have a strong competitiveness.
The solutions passed through reforms!
We will show you with both theory and
evidence how would this work and how
large the effects might be.
Social protection systems have two different
origins in Europe : Beveridgian and
Bismarckian.
William Beveridge (1879-1963) Otto Von Bismarck (1815-1898)
I. What is social protection?
In the Beveridgian model, which was born in
the UK after the Second World War : rights
to a basic social protection are universal and
granted to everyone.
In the Bismarckian model founded in
Germany in 1880, rights are granted to
those who work.
The first one, funded by a personal income,
provides uniform benefits to everyone, while
the second is based on the mechanism of
social insurance,where benefits are the
contrepart of contribution.
Social contributions: There are 5 which correspond with different covered risks: -sickness, motherhood, disablement and death -old age benefits -widowhood -family charges -work accident Assigned taxes are : -taxes on income and capital -transfer of tax resources -tax on specific products like alcohol or tobacco. State contributions finance RSA spendings.
Social protection financing in France
II. Empirical view
Total tax level1996 change
Social security contributions
Employees1996 change
Employers1996 change
OECD 37.7 +11.7 3.0 + 1.5 5.8 + 3.1
EU-15 42.4 +14.2 4.2 + 2.0 6.9 + 3.3
Denmark 52.2 +22.3 1.3 + 0.2 0.3 – 0.2
France 45.7 +11.2 5.9 + 3.6 12.2 + 3.5
Germany 38.1 + 6.5 6.7 + 3.0 7.8 + 3.2
UK 36.0 + 5.6 2.6 + 0.5 3.4 + 1.1
US 28.5 + 4.2 3.0 + 1.8 3.7 + 1.9
Japan 28.4 +10.1 4.1 + 2.8 5.3 + 3.6
A similar evolution between OECD and EU countries. 40% of the general increase of the tax level in the EU is explained by higher social security contributions
Tax mix
The reduction of the share of personal income
The expanding share of social security contributions
The fastest growing revenue source have been general consumption taxes (like VAT).
In 2009, the overall
tax-to-GDP ratio
(including Social
Contributions) in the
European Union
amounted to 38.4% of
GDP, more than one
third above the levels
recorded in the United
States and Japan.
Source: European Commission, Taxation trends in the EU, 2011 edition
•Within the Union, there
are disparities between
member states about
overall taxes.
Source: European Commission, Taxation trends in the
EU, 2011 edition
Convergence
•Is there any convergence towards some common financing model in the EU ?
•Are there tendencies towards using more tax financing ?
The structure of social protection financing
Public financing General government public non-contributory schemes and financial support to other resident social protection schemes.
Employers’ contributions The costs incurred by employers on behalf of their employees.
Contributions paid by insured persons The costs incurred by protected persons to secure entitlement to social benefits.
Other financing Transfers from other schemes and such sources as interests and dividends.
Absolute convergence
Sala-i-Martin (1996)
The study by Sala-i-Martin, in 1996, is applying the conventional approach, which utilizes cross-sectional regressions in a classical convergence analysis. Absolute convergence exists when there is a catching up phenomena. It means that the lower the level at the beginning of the period is, the higher the growth rate is. The results are presented in the four scatter diagrams which represent the shares by capita of public financing, employers' contributions, contributions by insured, and share of other financing. The initial share level is on the horizontal axis and the annual growth rate on the vertical axis. A regression line has been drawn for each financing share. There appears to have been absolute convergence in all financing shares during the 15-year period from 1980 to the mid-1990s. The convergence has, however, been quite modest, with the exception of the financing share of insured persons, which has experienced quite rapid convergence.
Different options to reduce the tax burden on employment
1) The VAT rise effect
2) The CSG rise effect
3) The increase of corporate taxation
4) The introduction of a value-added tax
source : Malinvaud's report (1998), Besson's report,
(2007)
III. Theoritical view
Different options to reduce the tax
burden on employment 1) The VAT rise effect
increase in prices → lower purchasing power
Consequences :
firms which benefit from the employers'
contribution 's reduction will not raise their prices
to be still competitive
firms increase their workforce demand →
increase of real wage so increase of the real
labour cost.
Different options to reduce the tax
burden on employment
VAT rise improves French competitiveness through
two effects :
→ on the domestic market, foreign products
suffered from the same tax rise than french
products but national companies benefit from a tax
allowance so the weight of the VAT rise is
moderated for national companies as compared to
others.
→ french exportators escape the VAT rise and in
the same time face a reduction of their social
contributions so they easily reduce their prices and
french exportations are cheaper than foreign ones.
Different options to reduce the tax
burden on employment Final results :
→ real labour cost lower and employment level
higher than before the tax reform
→ a 3 points increase in VAT could lead to a
competitiveness gain of 0,1 to 0,3 points
and the creation of 100 000 jobs in average.
Fiscal devaluation effects (source : International Monetary Fund (2011), “Fiscal Devaluation:
What it is –and does it work?)
Domestic tax changes as a potential response to difficulties in some euro area countries, in the specific form of a revenue-neutral shift from employers’ social contributions toward a value-added tax.
Such a reform has come to be known as a “fiscal devaluation”.
It's expected to reduce the foreign currency price of exports and raise the relative consumer price of importables
The higher VAT rate bears on domestic consumption, but not on exports, it offsets the impact on domestic consumer prices of the reduction in domestic producer prices, and it increases the consumer price of imports.
Foreign demand for exports increases and domestic demand for imports falls; consequently, the current account improves.
The mechanism is the same as a depreciation of the real exchange rate.
The fact that the effects of a fiscal devaluation may largely be temporary does not mean that they are irrelevant
Nevertheless, Feldstein and Krugman (1990)
argue, for instance, that tradables are generally
taxed more heavily under the VAT than
nontradables. Indeed, a higher standard VAT rate
then reduces the relative consumer price of
nontradables, encouraging substitution out of
tradables.
Social deadweight loss due to a VAT rise
Explanation
The surface of the Haberger triangles represents the social loss measured by :
To minimise distorsions caused by the VAT increase the government has to follow the Ramsey Rule : taxation should be inversely proportional to tax elasticities :
Implications → equity trouble because it states that government should tax essential goods and unskilled workers.
Different options to reduce the tax
burden on employment
2) The CSG rise effect
Same effect as regards employment as for
the case of the VAT rise.
CSG versus VAT
In cases 1) and 2), the employers contribution's
decrease is balanced by a taxation on
households:
On their income for the CSG
On their consumption for the VAT
But the tax weight will be less hard to
assume for consumers with the CSG option
than with the rise of the VAT.
Different options to reduce the tax
burden on employment
3) The increase of corporate taxation
Levying on the value-added
But many drawbacks :
→ penalisation of french firms compared to
competitors
→ a taxation base more narrow than for VAT or
CSG so needs to increase a lot the tax to
compensate the social contributions ' decrease.
→ may be supported mainly by employees ' real
wage
Different options to reduce the tax
burden on employment
4) The introduction of a value-added tax
Consists in capital taxation (near of the corporate
taxation and CSG principles)
But also land and holding incomes taxation
In the long-run, effects on employment similar to
VAT or CSG rise effects.
Trouble : economic fluctuations as regards capital
are less regular than fluctuations correlated to the
payroll.
Drawback : detrimental to corporate innovation.
How to evaluate a financing reform?
Several macroeconometric models tried to forecast the VAT rise in terms of domestic output, competitiveness and employment in France in the short and the long run.
Conclusions :
* A reduction of 9,3bn euros in employers contribution's balanced by a VAT increase will lead to 22000 jobs according to the Mesange Model and 47000 jobs within 2 years according to the general equilibrium model.
* Besides the same reduction balanced by a CSG increase is likely to create 46000 jobs for The Mesange model and 47000 jobs for the general equilibrium model.
Finally, a reduction of 9,3bn euros in employers contribution's (2/3) and employees' contributions balanced by a VAT increase will lead to 5000 jobs according to the Mesange Model and 31000 jobs within 2 years according to the general equilibrium model.
The macroeconometric model :
It is primarily intended to evaluate economic policies in the short and medium term. The model follows a logical "neo Keynesian.
In the short-term effects dominate demand (consumption, exports). This model takes into account the existence of adjustment costs and a degree of price stickiness in the short term. The long-run equilibrium of the model is determined by the supply behavior including the labor market
The macro-econometric models are constructed from a large number of behavioral equations and accounting. Behavioral equations are estimated independently of each other and parameters adjustment of short-term are not always obvious economic interpretation. It is therefore assumed when evaluating a given measure of economic policy agents' behavior and their expectations are not modified.
it was assumed that the real interest rate long-term is not affected. This is justified by the fact that there was little change
inflation in the economy, we can assume that monetary policy remains more or less restrictive than in the central account
The dynamic general equilibrium model
The dynamic general equilibrium model based on a structural model of the economy, taking into account the objectives and constraints of various economic agents in the calculation of the overall balance.
Domestic firms produce goods to sell to domestic and foreign households. Domestic households consume domestic goods and foreign saving in the form of bonds, they provide labor and capital to firms. Foreign households consume domestic and foreign goods, they lend or borrow in bonds to domestic households. The state tax companies and domestic household expenditure and revenue in the transfer households. Finally, the European Central Bank reacts to domestic and foreign inflation rates by changing the nominal interest rate in the euro area the general equilibrium model shows from the short-term effects offer significant, This model can better identify from the short-term channel transmission reforms studied.
In dynamic general equilibrium model, firms set their prices to maximize their profits: the behavior of firms margin is endogenous.
Gallois' Report : what about a tax
reform ?
Main objective : a euros 30 billion drop (1,5%
GDP) in social contributions.
A reduction that aims at boosting French firms'
competitiveness : lower more employers'
contributions (2/3) than employees' contributions
(1/3).
Degressivity of the social contribution until 3,5
times the minimum wage.
Gallois' Report : what about a tax
reform ? Solutions to compensate this 30bn drop in social
contributions :
→ VAT increase, could finance 5 to 6bn euros with the
intermediate rate switch from 7% to 10% and the
normal rate that switches from 19,6% to 20%
→ CSG increase, government could earn a gain of 20
or 22bn euros.
→ tax on financial transactions, could bring in 2 to 3bn
euros.
→ carbon tax suggested
Other aspects of the issue (source : Financing social protection, the employment
effect, the OECD employment outlook, 2007)
Social protection financing drives a wedge
between total labour costs and what finally
remains in the worker's pocket : the higher the
public spending on the social protection, the higher
the tax wedge.
The extent to which a higher tax wedge has an
impact on employment depends on :
- the progressivity of funding system
- the link between what is paid and expected benefits
- how labour taxation affects wage claims and replacement income
Cutting payroll taxes (source : Economic policy class, Bénassy-Quéré)
Other aspects of the issue
General conclusions to keep in mind :
* the negative effect of the tax wedge is more
strong for low paid employees.
* stronger tax progressivity → lower tax wedge
on low-paid workers, so it may improve the
jobs prospects of vulnerable groups
* so equity seems to be linked with economic
efficiency → increasing competitiveness
needs to pay attention to the weight of
labour costs on low wages.
Conclusion
To conclude, European countries hold on high level of social protection by switching social contributions to indirect taxes (VAT for instance).
This transfer permits a better economic efficiency (improvement of competitiveness with reduction of labour cost) and may not reduce social justice. However, it could be limited by a loss of purchasing power for employees.
Conclusion
If a compensation by an increase of VAT does not reduce entirely distortions made by social contributions, mainly for employment, a new theoretical trend mentions social protection may be financed by environmental taxes (carbon tax) and taxation on the financial transactions in order to reduce distortions.
Besson E. (2007), TVA sociale, rapport pour le Premier
Ministre, Paris, La Documentation Française.
European Commission (2010), Taxation trends in the
European Union 2011, Luxembourg: Publications Office of
the European Union.
Farhi, E., Gopinath, G. and O. Itskhoki (2012), “Fiscal
devaluations”, mimeo, Harvard University.
Finnish Ministry of Social Affairs and Health (1999),
Financing Social Protection in Europe,
background material for the EU Conference on Financing
Social Protection, Helsinki, 22 – 23 November.
References
International Monetary Fund (2011), “Fiscal
Devaluation: What it is –and does it work?,” in: Fiscal
Monitor, September.
Gallois L. (2012), Pacte de compétitivité pour
l’industrie française, rapport pour le Premier Ministre,
La Documentation Française.
Malinvaud, E. (1998), Les cotisations sociales à la
charge des employeurs : analyse économique, rapport
du Conseil d’analyse économique, No. 9, La
Documentation Française.
OECD (2007), “Financing Social Protection: The
Employment Effect,” in OECD Employment Outlook,
Paris: OECD, Chapter 4.
A.Bénassy Quéré, B.Coeuré and J.Pisani-Ferry
(2010), Economic Policy : Theory and practice