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