The current economic situation forces the governments to find solution how to promote economic growth. Economic theory suggests that differences in taxation may play a role in explaining differences in economic performance. The paper summarizes common features tax related measures used to tackling the economic recession in the European Union and it also points out the effect of taxes on economic activity presented by empirical studies.recession; economic crisis; taxation; corporate income tax; personal income tax; value added tax

Szarowska, Irena

English

Research Papers in Economics

Recession, taxes and economic growth  
IRENA SZAROWSKÁ 
Abstract 
The  current  economic  situation  forces  the  governments  to  find  solution  how  to 
promote economic growth. Economic theory suggests that differences in taxation may play a 
role in explaining differences in economic performance. Paper summarizes common features 
tax related measures used to tackling the economic recession in the European Union and it 
also points out the effect of taxes on economic activity presented by empirical studies.  
Introduction 
The  current  economic  situation  forces  the  governments  to  find  solution  how  to 
promote economic growth and to consolidate public finance. There are different views of how 
this problem should be dealt with in general and also applied tools of individual countries 
have  various  forms  –  from  ad  hoc  tax  measures  to  substantial  structural  reforms.  It  is 
questionable  whether  the  governments  may  affect  the  economic  performance  of  countries 
through changes in taxation. Although economic theory suggests that differences in taxation 
may play a role in explaining differences in economic performance, the effect of taxes on 
economic  activity  is  one  of  the  least  contested  areas  in  theoretical  macroeconomics. 
Nevertheless, it is generally difficult to assess the overall effect of the tax changes on gross 
domestic product (GDP). For example changes in any single tax may simultaneously affect 
several determinants of GDP and its growth. The aim of the paper is to summarizes common 
features tax related measures used to tackling the economic recession in the European Union 
(EU) and it also points out the effect of taxes on economic activity presented by empirical 
studies.  
1  Economic recession and its impact on economic performance  
The impact of the economic crisis and recession on economic performance and public 
finance varies across European Union members. There are 27 sovereign member state in the 
EU with independent tax policy and none of them are identical. Each government has been 
dealing with its problems individually and the choice of instruments for crisis management is 
influenced  by  many  factors  as  for  example  divergence  in  economic  performance, 
consequences of the crisis on economic growth, employment, inflation, balance of payments, 
export,  etc.  It  is  important  to  be  aware  of  the  time  constrained  function  and  assess  their 
potential  impact  on  long-term  fiscal  stability  when  applying  anti-crisis  measures.  The variability of these measures reflects the economic and budgetary conditions of individual 
states. Such measures may have a general fiscal impact or only a cash flow impact
1.  
In countries with strong macroeconomic imbalances and/or where the bursting of an 
asset  bubble  adds  to  the  effect  of  the  global  downturn  (e.g.  the  UK),  the  budgetary 
deterioration  is  more  pronounced  than  in  other  countries.  In  some  of  these  countries  the 
increase  in  government  deficits  combined  with  low  growth  is  set  to  give  rise  to  a  large 
increase in debt positions. Figure 1 shows development of total revenues and expenditure in 
European Union. 
Figure 1: Total revenue and expenditure (four-quarter moving average), EU 
 
Source: European Economic Forecast Autumn 2009, p. 31. 
There  are  different  views  how  the  problem  with  GDP  decrease  and  public  debt 
increase should be dealt with in general and also applied tools of individual countries have 
various forms – from ad hoc tax measures to substantial structural reforms. The removal of 
tax barriers which hamper the effective functioning of financial markets, particularly at the 
international level, could help countries exit from the crisis. This include tax provisions which 
distort investor choices as to whether to invest directly or by means of collective investment 
vehicles, and tax provisions which act as a barrier to the use of different financial products 
which  reduce  the  cost  of  capital.  Governments  should  also  consider  the  broader  tax 
implications of the government bailout packages for financial institutions and how they may 
influence the future attitudes of these institutions to risk taking
2.  
                                                 
1 Dvořák (2008), p. 326-331. 
2 Valentine, T., Gordon, C. (2009), p. 8-11. 2  Common  features  tax  related  measures  in  European  Union 
member states3 
Tax measures implemented in a period 2008 – 2010 is possible to divided into several 
groups. One of the most common types of tax measures was the direct support of household 
spending power by reductions in the personal income taxes (PIT). This happened more often 
through increases in allowances than cuts in rates, because of equity considerations but also 
because an increase in allowances, having a proportionally higher impact on lower-income 
households, is expected to more directly boost private consumption. In a few cases, PIT rates 
were  even  increased,  but  this  was  typically  limited  to  higher  incomes.  Some  countries 
suffering from particularly pronounced drops in GDP decided to defer previously decided PIT 
rate cuts.  
Table 1: Tax measures taken in EU Member States in a period 2008-2010 
 Lowering Taxes    Increasing Taxes 
Labour Taxes          
Personal Income Tax   DK, FI, FR, DE, HU, LV, LT, 
LU, MT, NL, PL, PT, SI, SK, SE  
EL, IE, UK  
     
SSC Employers   CZ, FI, HU, NL, SE    IE, RO, UK 
SSC Employees   CZ, NL, SE, SK    LT, RO, UK 
Withholding taxes   BE      
Deductions    BG, DE, IT, PT, SK, ES, SE     
Capital Gains   RO IE   IE  
Deferral of reform       CZ, EE  
Corporate Income Tax          
CIT rate  CZ, EL, LU, PT, SE   IT, LT  
Allowances   BG, ES, IT, NL, DE, FR, LT, PL, 
PT, SI, SK  
  
Value-Added Tax          
Standard Rate   UK   FI, HU, IE, LV, LT  
Reduced Rates   BE, CY, CZ, FI, FR, MT, RO   HU, EE, IE, LV, LT  
Property and inheritance taxes   EL, ES, IT, LU, PT      
Environmental taxes    DE, NL, RO   FI, IT, LV, LT, SI, UK  
Source: based on data from Taxes in Europe [database online] and Taxation trends in the European Union (2009) 
Another group consists of measures relating to corporate taxation. Measures reducing 
the general corporate income tax rate were rare, presumably owing to the fact that such a 
measure, while boosting confidence in the long run, has no short-term impact on loss-making 
companies.  Many  member  states  also  attempted  to  support  business  investment  through 
                                                 
3  Based  on  data  from  Taxation  trends  in  the  European  Union  (2009), Tax  responses  to  the  global 
economic crisis (2009) and European Economic Forecast Autumn 2009. measures such as more generous depreciation allowances or investment tax credits. The cuts 
were targeted towards small and medium enterprises in a few cases. Some European states 
have opted for granting these incentives for a limited period of time only, in order to give an 
immediate boost to capital spending.  
Ad to indirect taxation, EU member states have generally not opted for temporary 
VAT  rate  cuts  as  a  way  to  boost  consumer  spending  in  the  short  run.  One  exception  is 
possible to find as Finland decreased VAT on food. In contrast, a number of Member States 
hiked VAT rates, curtailed the scope of exemptions and reduced rates, or increased excise 
duties to help cover the budgetary shortfall generated by the slump. Member States did not cut 
excise duties on energy products, although for example Italy cut excise duties on gas for 
industrial use and granted some tax and social contributions relief to road haulage operators. 
One  more  effect  of  the  crisis  can  be  seen:  demands  for  fairness  have  come  more 
clearly  to  the  forefront.  This  idea,  together  with  the  budgetary  needs,  has  stimulated 
international cooperation on ensuring more effective taxation of portfolio investments held 
abroad. There is now visibly greater international consensus on information exchange, the 
final  objective  of  the  Savings  Directive  and  of  the  Mutual  Assistance  Directive,  which 
represent the EU approach in this area. 
3  The  effect  of  tax  burden  on  economic  growth  in  empirical 
studies 
It is questionable whether the governments may affect the economic performance of 
countries  through  changes  in  taxation.  Theoretical  effect  of  taxation  on  economic 
performance is not an obvious matter and it is one of the least contested areas in theoretical 
macroeconomics. A higher level of tax burden can be seen as a serious obstacle to sustained 
improvement of economic level of the country. Taxes cause distortions in economic activity, 
may reduce the level of savings and investment, discourage work and entrepreneurship, and 
last but not least create the conditions to increase the informal economy. Scully (1991) says: 
“Taxes  levied  by  government  may  have  both  positive  and  negative  effects  on  economic 
growth. The value of economic resources and the ability to transform resources into output 
are greater to the degree that property is protected, roads and harbours are provided, and 
domestic tranquillity is insured. Taxation beyond this level may have a negative effect. In 
modern  times,  many  private  goods  are  provided  at  public  expense  and  direct  income 
redistribution takes place on a large scale. At some level of taxation, resources employed in 
the public sector are less than in the private sector and resources escape into informal or 
underground economy – which diminish economic growth.” 
Both neoclassical and Keynesian theoretical models, for example, predict that higher 
taxes reduce economic activity, even though there is less agreement on the exact mechanisms 
that generate this result. On the other hand, taxes may be benefits for the economy because the taxes are the basic source for financing public goods and services and in this way can 
increase the living standards and wealth of the whole society.  If  collected taxes are used 
efficiently, provided public services can increase productivity of human and fixed capital in 
private sector and promote long-term economic growth. 
Using statistical data for comparing level of taxation and economic performance also 
does  not  provide  unequivocal  conclusions.  We  can  find  countries  with  high  economic 
performance, which have a low tax burden (e.g. United States), but also countries that have 
high economic performance with high tax burden (e.g. Scandinavian countries). But there are 
many studies which present negative relationship between taxes and economic growth and 
recommend lowering tax rates.  
Scully (2000) claims that countries in which government takes more than 43 % of 
national income in the form of taxes could collect more revenue by lowering their tax rates. 
Further, tax rates anywhere close to 43 % have devastating effects on economic growth. Hill 
(2008) built on the Scully´s work and estimated that the growth-maximizing size of the state 
for the United States in 1960-1990 was between 9% and 29% of GDP.  
Also Romero-Ávila and Strauch (2008) state that government consumption and direct 
taxation negatively affect growth rates of GDP per capita in the EU – 15 in the last 40 years. 
Johansson et al. (2008) investigate the design of tax structures to promote economic growth. 
“Corporate taxes are found to be most harmful for growth, followed by personal income 
taxes, and then consumption taxes. Recurrent taxes on immovable property appear to have the 
least impact.”  
Lee and Gordon (2005) explore how tax policies in fact affect a country's growth rate, 
using cross-country data during 1970-1997. The coefficient estimates suggest that a cut in the 
corporate tax rate by 10 % will raise the annual growth rate by 1 to 2 percentage points.  
Karras  and  Furceri  (2009)  examine  the  effects  of  changes  in  taxes  on  economic 
growth. Using annual data from 1965 to 2003 for a panel of 19 European economies, the 
results show that the effect of an increase in taxes on real GDP per capita is negative and 
persistent: an increase in the total tax rate by 1% of GDP has a long-run effect on real GDP 
per  capita  of  –0.5%  to  –1%.  The  findings  also  imply  that  increases  in  social  security 
contributions or taxes on goods and services have larger negative effects on per capita output 
than increases in income tax.  
Szarowská (2010) analyzes the effect of tax changes on GDP growth using annual data 
from the 1995 to 2008 for a panel of 24 European Union members. Results of empirical tests 
verify statistically significant negative effect of tax burden on GDP growth. Total tax quota 
increase by 1% decreases the GDP growth rate by 0.29 percentage point in the same year. 
Estimations confirm statistically significant negative effect of direct taxes on GDP growth as 
well. A cut in the direct tax quota by 1 % raises the GDP growth rate by 0.43 %. Model also 
presents negative correlation between corporate income taxes and GDP growth. Regression coefficient (- 1.28) expresses high negative impact of an increase the corporate income taxes 
on GDP growth. On the other hand the effect of social contribution quota on GDP growth is 
not statistically significant in any estimation. 
Conclusion 
The  current  economic  situation  forces  the  governments  to  find  solution  how  to 
promote economic growth. As it was written there are large differences in both tax levels and 
tax structures across EU members. Economic theory suggests that these differences may play 
a role in explaining differences in economic performance. The response to the recession may 
have  various  forms.  Some  European  Union  member  states  have  decided  to  introduce 
substantial  structural  reforms,  reduce  tax  burden  from  income  taxation  and  increase  tax 
burden of consumption, or have introduced a unified VAT rate. Other states have made only 
minor changes and amending the tax codes by introducing measures protecting the tax base. 
There are 27 sovereign member state in the EU with independent tax policy and none of them 
are identical. Each government has been dealing with its problems individually and the choice 
of  instruments  for  crisis  management  is  influenced  by  many  factors.  International  tax 
cooperation in tackling economic crisis is limited to the determination of what member states 
should refrain from doing, such as protectionism, discrimination of non resident taxpayers, 
and reverse discrimination of resident taxpayers. 
It is necessary to point out results of many empirical studies which present negative 
impact of taxation on GDP growth. That's why the changes of tax rates should not be regarded 
as a single tool affecting the economic growth as the GDP growth is influenced by many 
factors. Moreover, it is generally difficult to assess the overall effect of the tax changes on 
GDP. For example changes in any single tax may simultaneously affect several determinants 
of GDP and its growth. The effects of changes in taxation often depend also on the design of 
other policies and institutions. Thus, the negative effect of labour taxes on employment often 
dependents  on  wage  setting  institutions  which  determine  e.g.  minimum  wages,  which 
negatively affect on labour cost and then GDP growth. 
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Kontakt 
Ing. Irena Szarowská, Ph.D. 
Slezská univerzita v Opavě, Obchodně podnikatelská fakulta v Karviné 
Univerzitní nám. 1934/3 
733 40 Karviná 
Czech Republic 
Email: szarowska@opf.slu.cz 

Daňové zatížení a ekonomický růst v Evropské Unii. In: Teoretické a praktické aspekty veřejných financí. Vysoká škola ekonomická,

Deloitte: Tax responses to the global economic crisis [online]. Url http://topic.feeds4all.nl/Deloitte-Report-Tax-responses-to-the/1718503753.aspx

Economics in Focus: The Global Financial Crisis. Pearson Education Australia,

European Commission: European Economic Forecast Autumn

Optimal taxation and economic growth.

Public finances and long-term growth in Europe: Evidence from a panel data analysis.

Tax rates, Tax Revenues and Economic Growth [online]. National Center for Policy Analysis,

Tax Structure and Economic Growth.

Taxation trends in the European Union. Office for Official Publications of the European Communities,

Recession, taxes and economic growth.

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