Tax mixes and the size of the welfare state: causal mechanisms and policy implications

Abstract

This paper questions the argument that strong and early reliance on ‘regressive’ taxes (consumption and payroll taxes) made it politically easier to build and maintain a large welfare state. It develops an alternative perspective which differs in two respects. First, a crucial ‘advantage’ of regressive taxes is that they imply moderate capital taxation, but this can also be achieved within income tax. Second, the direction of causality moves largely from high revenue needs to strong reliance on at least one of the two major regressive taxes, rather than the other way round. The paper aims to show that this alternative argument provides a better explanation of quantitative data patterns as well as the cases of Denmark, New Zealand, South Korea and the United Kingdom. Policy implications are also discussed: policymakers have good reason to defend the progressivity and revenue-raising potential of the income tax, and in so doing may require greater European tax coordination.

Keywords

capital taxation EU tax harmonization tax mixes welfare state development welfare state retrenchment

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