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How Europe should change tax policy?

Last June Eurostat published the 2014 edition of ‘Taxation trends in the European Union‘ which outlines current tax and social security issues within EU. According to the report European economy experiences recession and one of the catalyzing factor of the process is current tax policy. More recently, the president of the European Central Bank (ECB) announced that governments should cut taxes if they think it will help drive growth and create jobs. Several steps have already been taken, in January France announced plans to cut payroll taxes by €30 billion ($42 billion). This month Italy unveiled income-tax cuts worth €10 billion for those earning less than €25,000 a year. Britain also proposed tax cuts for most people on low or medium incomes. Ireland and Spain are also planning tax cuts. But still, it is not enough.

In order to be effective tax policy should deal with several factors. It must be structured in a way that encourages people to invest into economy. Effective tax policy encourages work, not discourage it, and it should boost money to be invested primarily in order to get return, but not tax avoidance. Usually, when taxes are high, investments that are made avoid tax effect or there is another scenario when people reduce their earning effort because the return seems of marginal worth.  This is how countries end up with tax policy that becomes counterproductive and a drain on economic activity.  Consequently,  investments are not made and jobs are not created.  This is exactly what is occurring today under current european tax policy.

Effective tax policy should have a couple of goals. First, it must be seen by the people as fair and understandable, which ensures a high level of compliance and raises the revenues needed to run the government. Second, it should be structured in a way that encourages people to invest in productive ways. How to fix it? During recessions, the governments mostly provide a tax cut as an economic stimulus. Since there is a high rates of unemployment across the euro area cutting taxes is essential grow demand.  Advocates of tax cuts argue that reducing taxes improves the economy by boosting spending. This strategy could have positive effects even in the short-term. Tax cuts boost business. Employers who are struggling to pay their bills (including national and local taxes), are not likely to think about hiring more people. But a tax cut would make a crucial marginal difference to them. Europe need a law that is fair, simpler and progressive.

Overall, such reforms are costly. For instance, Italy spends 8.1% of its GDP on such tax breaks a year, but definitely worth of it. A major tax rewrite is critical to get Europe on the right track.

 

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