More for less: What tax system for Poland? | 150th mBank-CASE Seminar
More for less: What tax system for Poland?
That was the theme of the 150th mBank-CASE Seminar, held on June 22 in cooperation with Łazarski University, which also hosted the event.
The goal of the seminar was to initiate a discussion on the subject of a tax system for Poland, presenting a framework within which the current system should be analyzed and conclusions drawn about what changes are needed over the longer term. The first speaker was Professor Stanisław Gomułka, chief economist of the Business Centre Club, with a presentation titled The tax system in the light of the challenges facing the Polish economy over the next 20 years. He was followed by Jarosław Neneman, an assistant professor at Łazarski University, who presented the basic parameters for a planned academic research project on how to use the Polish tax system effectively. The third speaker, Michał Myck, director and board member of CenEA (the Center for Economic Analysis) described the optimal characteristics of a tax system according to theory and the results of scholarly research, which of course also relates to the Polish tax system.
Problems of taxation and challenges for the Polish economy
Professor Gomułka presented the presuppositions that should be taken into account when reconstructing Poland’s tax system over the next 20 years. He named the biggest problems facing the Polish economy, which, as he stressed, are well known: low domestic savings, which bring with them low domestic investment; low labor-force participation and a declining population (and the resulting risk of a significant drop in employment); this leads to a growing risk of a deep slowdown in economic growth. As a result, the process of closing the income gap with highly developed parts of the EU may be halted. That in turn could lead to higher emigration. Another challenge is the risk that Poland won’t fulfil the fiscal criterion for entering the Eurozone.
In light of the need to face up to these problems and challenges, Professor Gomułka says the main goal for the next 20 years should be an almost complete elimination of the budget deficit. The ratio of debt to GDP was not as dangerous in the 1990s because of inflation, which gave us strong growth in nominal GDP, though as the speaker pointed out, over the next 20 years the situation will certainly be different. Thus, the balance of public sector finances should be in the range of a surplus of up to 2% of GDP during times of growth, to a deficit of 2-3% of GDP during recessions. This is a necessary and sufficient condition for achieving stability of public finances. With an average deficit close to zero, it would be possible to systematically reduce the ratio of public debt to GDP from the current level, close to the maximum allowed level of 60%, to less than 30% in 20 years. Reducing this ratio is particularly necessary over the next few years, in order to create a macrofinancial stability reserve before the country enters the Eurozone.
Professor Gomułka also set auxiliary targets for this main goal, such as achieving the goals of redistributive social policy through the spending side of the ledger rather than taxation; reducing the deficit in the retirement system; tightening up the tax system; and changing tax policy to encourage labor force participation and slow the pace of depopulation. However, an obstacle to the achievement of these goals, the professor said, is posed by the provisions of the Constitution that forbid public-private co-financing of health and education services, as well as citizens’ limited rationality on questions of retirement and aging. Also, in the pension system itself there are instruments that would allow these challenges to be addressed. The second principle of taxation would be limiting the tax burden on labor and capital in favor of taxing consumption spending, which encourages work and savings. VAT rates should also be modified to make lower rates the rule, not the exception.
More for less
Jarosław Neneman started his presentation by stating that in Poland for every PLN 100 of GDP, PLN 41 passes through the state budget, which is a high ratio. But comparing Poland’s ratio of taxes and social insurance contributions in relation to GDP with those of other European countries, we reach the conclusion that we are at the bottom of the list. These relations are of course an effect of political decisions. Moving to questions of the structure of tax revenue in Poland in comparison with other EU countries, the speaker pointed out the very high share of inflows from contributions (40%), and the very small share in tax income of direct taxes (20%). At the same time, he stressed that indirect taxes are considered better than taxes on personal income or capital gains, or social-insurance contributions. With a 40% share of direct taxes in tax revenue, Poland is in the middle of the list of 28 EU countries.
Next, Mr. Neneman presented an overview of the taxes applied in Poland. He assessed the personal income tax as a good tool for redistribution: The rich pay more than the poor. In Poland this tax is not very progressive, and for entrepreneurs it is regressive. We have a law that allows joint filing of PIT by married couples, which is attractive for couples in which there is a broad difference in earned income. But joint filing can also be perceived as a disincentive for non-working spouses to start work. Social-insurance contributions are relatively high in Poland and the role of corporate income tax in the system is not significant. The situation is different with excise tax, which in Poland is a significant source of revenue. But the property-tax situation varies: taxes on properties for businesses are relatively high in Poland, while those on dwellings are low.
Moving into the second part of his presentation, dedicated to the characteristics that make up a “good” tax system, Mr. Neneman began with the statement that taxes should not serve merely to generate budget revenue, but should be structured so as not to encourage activity in the gray zone and not support criminal activity, instead encouraging an increase in the supply of labor and minimizing the negative effects related to globalization and services. The speaker also presented a concept for a research project that he is working on with a group of tax experts from the CASE Foundation. The purpose of the project is to indicate the actions that would make the Polish tax system more effective, assuming a constant level of fiscalism, and progressivity of taxes similar to the current level. The second purpose of the project is to raise the level of discussion of taxes, and prompt a reconsideration of the theories spread by populists.
Mr. Neneman presented the three pillars that should form the basis of an effective tax system: 1) neutrality (similar activities should be taxed similarly; taxes should neither encourage nor distort any actions); 2) progressivity (higher burdens should apply to those in better material situations – but not progressivity at any price, because costs mean something; it must also be remembered that some goals are better achieved through direct taxes and contributions than by indirect taxes and taxes on capital); 3) taxes cannot be examined individually, but must be looked at in combination, as elements of the tax system (taxes are interdependent; it’s not permissible to earmark tax revenues; pension contributions should be part of the system).
The speaker also called to mind the rules that must be followed when creating or changing a tax system: It should be simple, transparent, stable and fair (meaning two people who earn the same amount shouldn’t pay different levels of tax). He also noted that the bigger the tax wedge, the lower employment is, and in countries where small companies can take advantage of tax breaks, these companies don’t develop, because the tax system discourages it – which is also the case in Poland. Poland also has a problem with taxation of farmers, or rather with non-taxation. The rules of taxing farmers require serious discussion, and changing the current system could bring about a significant improvement in e.g. local-government revenues.
Which system is optimal?
In the last presentation at the seminar, Michał Myck discussed the results of academic research on the tax system, building his presentation around the term “optimal tax system.” The optimal taxation structure, according to the theory, is one where losses resulting from introduction of taxes is limited by adjusting their level relative to the elasticity of supply and demand for the goods and services subject to taxation. Research on the optimal tax system has referred to the principle that goods and services with low elasticity of demand should be subject to higher taxes, because in their case the loss of welfare measured according to so-called surplus consumers and surplus producers is lower than in the case of goods and services characterized by a high degree of reaction to price changes. But the purely negative consequences of the influence of taxes on economic effectiveness have become only an element of the introduction of the conditions necessary for optimum tax solutions, which treat the welfare function as the point of departure. If the purpose of the government (as the representative of the sovereign) is to maximize the total level of welfare, and not merely to minimize economic inefficiencies, a key role is played not only by the total level of goods and services generated, but also by their distribution. Whether the system is optimal will thus be determined by the welfare function adopted and the weights assigned to particular social groups, which are most often understood as the degree of the sovereign’s sensitivity to the level of inequality of resources in society.
Mr. Myck stated that the literature on optimal taxation offers the following important conclusions for economic policy: 1) reduction in the labor supply, similarly to reduction of production of goods and services, as a result of taxation reduces the general welfare; 2) reduction in the supply of labor will be an effect both of direct taxation of labor and taxation of goods and services, and the system of indirect taxes also has a material effect on the redistribution of income; 3) the effect of particular taxes on the welfare of various social groups depends not only on their level, but also on the tax incidence and on how various levies are treated; in this second case, a key role is played by the credibility and stability of the retirement system.
Mr. Myck addressed the arguments, frequently deployed in the public debate, that stress the advantages of shifting the burden of taxation from direct to indirect taxes (which Professor Gomułka discussed in his speech). It is stressed that this type of shift, by reducing taxation of labor, would lead to higher labor force participation and thus would increase the economic effectiveness of the entire system. But this argumentation is not directly reflected in the theory of taxation. If we assume that optimization of behaviors relates to the choice between consumption and free time, the argument is based on the change in their relative prices. When we tax either labor or consumption, the relative price of free time falls, which leads to an increase in demand for free time, meaning a reduction in the supply of labor.
In summary, Mr. Myck said that the most important conclusion arising from the academic literature on taxation is that particular elements should be subject to evaluation, but from the point of view of the tax system as a whole. What’s more, because behavior is influenced not only by taxes, but also – and often very strongly – by transfers and benefits, in assessing the tax system we cannot disregard the funds that households receive from the state. This means the effectiveness and degree of redistribution should be analyzed while considering taxes and benefits in conjunction.
Finally, Mr. Myck agreed with the conclusions of Mr. Neneman, stressing that the tax system should discourage economic activity as little as possible, achieve defined redistribution goals and be simple, transparent and fair.
After the three speakers’ presentations, there was a lively discussion between the speakers and the audience, as well as requests from participants for elaboration on certain issues presented during the speeches.