The effects of tax changes in the European Union on reducing income inequality

In this paper we discuss and analyze the effects that tax policies have on reducing income inequality in European Union (EU) member countries. We consider the EU economies as a whole, but, because of heterogeneous levels of development and policy differences that exist, also examine differences that exist between the “old” (EU-15) and “new” (EU-13) member states. In particular, numerous differences in tax structures and per capita tax burdens result from different fiscal priorities and systems across EU countries – particularly evident between old and new member states. The tax systems in the EU-15 are more established, but relatively complex and comprehensive. On the other hand, tax systems in the EU-13 are more transparent, neutral, and straightforward, though not necessarily more efficient. In terms of the tax structure, most EU-15 member states raise roughly equal shares of tax revenues from direct taxes, indirect taxes, and social contributions, while the EU-13 member states often display a substantially lower share of direct taxes in total tax revenues. Heterogeneous preferences of government policy goals result in different effects and uses of tax revenues which may, or may not, specifically target income disparities. In order to analyze differences across the various tax forms – labor, capital, consumption, and property, as well as social contribution taxes– we test the impacts of reforms over the sample period 2000-2013. We begin our analysis using fixed and random effect panel models. Next, given the dynamic nature of policy responses and the endogeneity problem, we extend the analysis to include dynamic panel IV methods. Initial results indicate that overall social contributions, social protection, and personal income taxes lead to statistically significant improvements in income inequality among EU member states. We also find there is a statistically significant difference between tax policy and income inequality between new and old EU countries. We conclude that tax policy, specifically the choice of taxes implemented, reduce income inequality in the EU-28 during the observed period.