Chapter

V An International Comparison of Tax Systems in Industrial Countries

Author(s):
International Monetary Fund
Published Date:
January 1994
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Author(s)
Enrique G. Mendoza, Assaf Razin and Linda L. Tesar1 

The precise measurement of tax rates that affect economic decisions at the aggregate level is critical to the design of economic models that simulate the effects of fiscal policies. The extensive analytical work on the macroeconomic implications of different tax systems produced during the last decade, as reviewed in Frenkel and Razin (1987), emphasized the importance of modeling explicitly the structure of incentives and constraints under which households and firms formulate optimal plans in order to produce reliable assessments of the effects of policies. This is particularly true in an environment of increasing international economic integration.2 The literature established that the models designed to simulate the effects of changes in fiscal policy must consider a realistic description of the rates of taxation prevailing in different countries before experimenting with alternative policies. The issue is particularly relevant in the context of current discussions on the implications of the convergence of fiscal policies envisaged for the European Community under the Maastricht Agreement and the agreements to harmonize indirect taxes, and on the effects of significant changes in the tax regime announced in the recent deficit-reduction plan for the United States.

Unfortunately, it is difficult to measure tax rates that are relevant for macroeconomic modeling. Many studies have been written on the measurement of effective marginal tax rates on labor and capital income.3 Each constructs estimates of marginal tax rates by combining information on statutory tax rates, tax returns, and tax codes with data on income distribution, household surveys, and projections of real present values for investment projects in specific industries. However, as Frenkel, Razin, and Sadka (1991) argue, the complexity of tax credits and tax exemptions, as well as the numerous equivalences that link broad categories of taxes, makes constructing effective marginal tax rates that affect actual economic decisions at the aggregate level extremely difficult. It is also difficult to show that marginal tax rates that apply to particular individuals in a household survey, or a specific aggregation of incomes based on tax-bracket weights, are equivalent to the aggregate tax rates that affect macroeconomic variables as measured in conventional national accounts systems. Moreover, detailed time series and international cross-sectional applications of methods for computing effective marginal tax rates are seriously limited by the available data.

Lucas (1990) and (1991) and Razin and Sadka (forthcoming) have opted for an approach that produces effective average tax rates, for the taxes that generate the majority of the government’s tax revenue, based on data on actual tax payments and national accounts. Their analysis suggests that these tax rates are useful approximations of the taxes that distort decisions by representative agents in macroeconomic models. Their method focuses on the information that national accounts data provide regarding post- and pre-tax prices and incomes, combined with figures that aggregate tax revenues by allocating them to taxes on consumption and factor incomes. This method, although less rigorous in the treatment of the tax laws, produces measures of the tax rates that are consistent with the representative agent assumption and, by looking at the aggregate data, it also takes into account the effective, overall tax burden resulting from each of the major tax categories (i.e., taxes on capital and labor income and taxes on consumption). In addition, this method is easier to implement in multi-country research projects because it exploits the international consistency of available data sources on national accounts and revenue statistics.

This paper describes an application of this method to compute time series of the effective average tax rates on consumption, capital income, and labor income for the group of seven largest industrial countries, using information publicly available from the Organization for Economic Cooperation and Development (OECD). Comparing these tax rates with some of the available estimates of effective marginal tax rates, we find that, despite differences, the tax rates reported here are within the ranges of marginal tax rate estimates and display similar trends. We also show that our estimates of the tax rates are generally consistent with some key predictions of macroeconomic models. In particular, in most countries, the savings rate is inversely related to the tax rate on capital income, the average number of hours worked is negatively correlated to the sum of the labor and consumption taxes, and the rate of unemployment is positively correlated with the labor income tax. The first two results are consistent with the intertemporal equilibrium model of savings in an open economy, as explained in Frenkel, Razin, and Sadka (1991); the second is consistent with models of equilibrium unemployment, or the “natural rate,” as in Pissarides (1985) and Adams and Coe (1990). The investment rate is also inversely related to the capital income tax, reflecting the well-known positive correlation between savings and investment, and suggesting that the rates of taxation affecting the returns on foreign and domestic capital tend not to offset each other.

Comparing the data across countries, we find that when tax rates on capital income are above average, savings and investment rates tend to be below average, and when labor income taxes are relatively high, the rate of unemployment tends to be higher and the number of hours worked tends to be lower. The international cross-sectional and time-series information is combined in panel data tests to formalize the evidence obtained from the inspection of correlation coefficients. Finally, the cross-country analysis highlights important differences in the distribution of the tax burden on consumption, labor income, and capital income between North America, Japan, and Europe, which indicate the magnitude of adjustment that policies of tax harmonization may require. The analysis indicates that consumption taxes in the United States are significantly lower than in Canada and the European Community, but that increasing the U.S. consumption tax could result in a higher natural rate of unemployment and a reduction in the number of hours worked.

Our analysis of the interaction between computed tax rates and macroeconomic variables is only a rough first approximation that illustrates the empirical relevance of the method proposed. Mendoza and Tesar (1992) examine some of the implications of current policies of fiscal convergence in a model of business cycles for integrated economies using the tax rates reported in this study. Razin and Yuen (1992) study the extent to which these tax rates can explain the international convergence or divergence of growth patterns. Finally, the proposed tax rates are also being incorporated into the multi-country macroeconometric model of the International Monetary Fund (MULTIMOD) with the aim of producing policy simulations in which the short-run and long-run interactions of the tax rates with other macro-aggregates of interest are taken into account.

A Methodology for Computing Effective Average Tax Rates

While the concept of the marginal tax rate that affects the decisions of economic agents is simple in theory, and quite easy to quantify at a microeconomic level, computing effective marginal tax rates that apply at a national or international level is quite difficult. Within one country, computing these tax rates is problematic (1) because tax revenue data and the tax system itself do not conform to the aggregate concepts of a macroeconomic model; (2) because the many exemptions and credits make it difficult to extrapolate the information from the statutory tax rates written in the law; (3) because equivalent effects may result from different types of taxes; and (4) because of the need to have available data on the distribution of income be consistent with systems of income tax and social security contributions. At an international level, differences in the structure of the tax systems and the limitations of the information available on tax revenues and income distribution further complicate the computation. Following Frenkel, Razin, and Sadka (1991) and Razin and Sadka (1993), we look at effective average tax rates based on actual tax payments and national accounts as a useful approach.

This section of the paper describes our method for computing effective average rates of taxation on consumption and the income derived from capital and labor services for the group of seven largest industrial countries. Using data from two publications by the Organization for Economic Cooperation and Development—Revenue Statistics of OECD Member Countries, OECD (1990) and National Accounts: Volume II, Detailed Tables, OECD (1991a)—we compute time series of the effective average tax rates for each country covering the period 1965–88. We use the same method as did Razin and Sadka (1993) to examine the structure of taxation in Israel,4 which was based on guidelines suggested by Lucas (1990) and (1991).

Razin and Sadka (1993) undertake a quantitative analysis of static and dynamic inefficiencies of taxation using a general equilibrium model of an economy inhabited by representative agents. Firms produce an aggregate consumption good using capital and labor services provided by households, and government levies ad valorem taxes on consumption, capital income, and labor income. Ad valorem tax rates are then derived as the ratio of specific tax rates (i.e., the difference between household and producer prices of each) to the producer prices. Calibration of the model using Israeli national accounts data on pre- and post-tax income and prices produces aggregate effective tax rates that correspond to realized average tax rates. Thus, the effective average tax rates aggregate the information on statutory taxes, credits, and exemptions implicit in national accounts in a manner that maintains consistency with the representative agent framework.

Description of the Data

The four-digit codes listed below identify different measures of tax revenue and correspond to the codes used in the OECD’s Revenue Statistics. The publication is extremely useful because it collects information on tax revenues from country sources and organizes it under a uniform format at the general government level and on a cash basis. Abbreviations in capitalized letters correspond to variables obtained from the OECD’s National Accounts: Volume II, Detailed Tables. This publication also takes information from country sources and attempts to organize it under a common format. Of particular importance for computing tax rates are the data at the disaggregated level that it provides on the detailed accounts for households, corporate enterprises, and government. The data from both sources cover the period 1965–88. The key to the variables is as follows:

Revenue Statistics Data

  • 1100 Taxes on income, profits, and capital gains of individuals

  • 1200 Taxes on income, profits, and capital gains of corporations

  • 2000 Total social security contributions

  • 2200 Employer’s contribution to social security

  • 3000 Taxes on payroll and workforce

  • 4100 Recurrent taxes on immovable property

  • 4400 Taxes on financial and capital transactions

  • 5110 General taxes on goods and services

  • 5121 Excise taxes

National Accounts Data

C=Private final consumption expenditure
G=Government final consumption expenditure
GW=Compensation of employees paid by producers of government services
OSPUE=Operating surplus of private unincorporated enterprises
PEI=Household’s property and entrepreneurial income
W=Wages and salaries
OS=Total operating surplus

Effective Average Consumption Tax Rate

In a simple equilibrium model of fiscal policy, where representative households purchase an aggregate consumption good and pay an ad valorem tax on their purchases, the consumption tax rate should correspond to the percentage difference between the post-tax price they pay and the pre-tax price at which firms supply the good. Thus, if we use the data collected from the OECD sources, the effective average tax rate on sales of consumption goods (tc) can be computed as follows:

The numerator is the revenue from indirect taxation (general taxes on goods and services plus excise taxes), which is equal, by definition, to the difference between the nominal value of aggregate consumption at pre-tax and post-tax prices. The denominator is the base of the tax, which is the pretax value of consumption—measured as post-tax consumption expenditures minus the revenue from indirect taxation. The formula takes advantage of the fact that nominal consumption expenditures in national accounts are at post-tax prices. Government consumption of goods must be included in the denominator because Revenue Statistics reports data on indirect tax revenue that includes taxes paid by government; however, this applies only to purchases of goods and nonfactor services. Hence, the compensation of government employees must be deducted from G. This formula is identical to the one used by McKee, Visser, and Saunders (1986) to compute the consumption tax that they incorporated in their calculations of effective marginal tax rates on labor income for OECD countries.

Effective Average Labor Income Tax Rate

The effective average tax on labor income corresponds to the percentage difference between post and pre-tax labor income. In practice, however, computing this average tax rate is difficult because of the manner in which data on income taxes and other taxes based on labor income are reported. One common problem, which also affects most computations of effective marginal labor income tax rates,5 is that tax revenue sources typically do not provide a breakdown of individual income tax revenue in terms of labor and capital income. We address this problem by assuming that all sources of the households’ income are taxed at the same rate—an assumption which according to 1991 tax laws in OECD member countries is a good approximation.6 Another concern is that, in addition to the individual income tax on wages, there are other important taxes based on labor income, such as social security contributions and payroll taxes. These are taken into account in the computations that follow.

We begin by computing the households’ average tax rate on total income (th) as

Thus, the representative agent’s income tax rate is the ratio of individual income tax revenue—which represents the difference between post-tax and pre-tax individual income—to pre-tax household income. The latter is defined as the sum of wage and nonwage individual income (i.e., the sum of wages and salaries, property and entrepreneurial income, and the operating surplus of private unincorporated enterprises).

Then we estimate the revenue from the income tax on wages and salaries as th*W and we compute the effective average tax rate on labor income (t1) as

In addition to the tax on wages and salaries, the calculation incorporates all social security contributions and payroll taxes, as part of the revenue derived from labor income taxes. It also makes a correction to expand the tax base to include the employers’ contribution to social security—since households are not taxed on the portion of compensation to employees that represents social security contributions by firms.

Effective Average Capital Income Tax Rate

Continuing under the assumption that all sources of the households’ income are taxed uniformly, we estimate first the revenue from the capital income tax on individuals as th*(OSPUE + PEI), and then we define the effective average capital income tax rate (tk) as

This formula represents the difference between post-tax and pre-tax capital income divided over pre-tax capital income. The difference between post- and pre-tax capital income includes, in addition to the households’ payments of capital income taxes, the payments of capital income taxes made by corporations,7 all recurrent taxes on immovable property paid by households and others, and the revenue from specific taxes on financial and capital transactions. The pre-tax capital income, which serves as the base of the tax, is the operating surplus of the economy as a whole (gross output at producers’ values less the sum of intermediate consumption, compensation of employees—which is wages and salaries plus employers’ contributions to social security—consumption of fixed capital, and indirect taxes reduced by subsidies).

Charts 14 show the time series of the effective average tax rates on consumption, labor income, capital income, and corporate capital income for each of the seven largest industrial countries.

Chart 1.Consumption Sales Tax

(In percent)

Chart 2.Labor Income Tax

(In percent)

Chart 3.Capital Income Tax

(In percent)

Chart 4.Corporate Capital Income Tax

(In percent)

A Comparison with Previous Work

The analytical framework from which the method for computing effective average tax rates was derived indicates that these tax rates are an accurate characterization of the wedge between pre-tax and post-tax prices in a representative agent, equilibrium model. Nevertheless, the method we presented does not consider explicitly the statutory tax rates and the peculiarities of the tax laws of each country, nor does it incorporate information on the income distribution according to income tax brackets and the schedule of social security taxes. These issues are examined thoroughly in the existing literature on the computation of effective marginal tax rates.

Consider first some of the studies that have focused on the computation of marginal labor income tax rates for the United States, as in Joines (1981), Seater (1985), and Barro and Sahasakul (1986).8 These studies compute effective marginal tax rates by calculating weighted averages of tax rates, or tax bills, per tax bracket, using as weights the shares of income on total income pertaining to each tax bracket. They take into account both income tax returns and social security contributions. Seater defines each tax bracket’s marginal tax rate as the ratio of the difference in the tax bill of that bracket minus the tax bill of the previous bracket divided by the difference in income earned by individuals in the same two tax brackets. Joines’s measure is similar, but it adjusts for the number of tax returns in each bracket and incorporates property, sales, and other proportional taxes. In contrast, Barro and Sahasakul compute their effective marginal tax rates by taking a weighted average of the statutory tax rates listed in income tax schedules. All three authors face the problem of individual income tax revenue data not providing detail on the revenue derived from labor income and capital income separately. Seater and Barro and Sahasakul set aside this problem by focusing on tax rates for individuals, without distinguishing between capital and labor income; while Joines takes a similar approach to the one adopted here, by assuming that personal income tax rates apply uniformly to capital and labor income.

Chart 5 plots the available time series for the effective marginal tax rates on labor or individual income from the studies mentioned above, together with the effective average tax rate estimates reported earlier in the paper. The chart illustrates clearly that despite methodological differences, which result in noticeable differences in the level of the tax rates, the general trend of the four series listed is very similar. Nevertheless, it is important to try to account for the factors that explain the differences in levels because theory predicts that the level of the tax rates has important implications on economic behavior. The Barro-Sahasakul rates are the highest because, by focusing on statutory tax rates, they abstract from the information on tax credits and exemptions that estimates based on actual tax returns can capture. The tax rates that Seater estimated using actual tax returns are the lowest, but considering Joines’s adjustments to take into account the number of returns per tax bracket and taxes that tend to be proportional to income—such as consumption taxes—the outcome is a series on labor income tax rates that is not very different from the effective average tax rates presented here. If the effective average consumption tax is added to the effective average labor income tax, the difference in Joines’s marginal labor income tax is negligible.9

Chart 5.Average and Marginal Labor Income Tax Rates

(In percent)

We focus now on international studies of effective marginal tax rates, in particular the study on capital and labor income taxes in OECD countries by McKee, Visser, and Saunders (1986), and the studies on effective tax rates on marginal investments by King and Fullerton (1984) and OECD (1991b). The tax rates on labor income constructed by McKee, Visser, and Saunders differ from those discussed above in that they do not represent weighted averages of tax-bracket data. Instead, their calculations are based on statutory taxes, tax returns, and post- and pre-tax labor income that apply at the level of the “Average Production Worker” (APW) as a reference for international comparisons.10 Their estimates incorporate payroll taxes, social security contributions, income taxes, and consumption taxes, assuming that individuals do not collect capital income—so that statutory taxes on individual income and individual income tax returns can be treated as corresponding to labor income taxes. Two sets of tax rates are produced, corresponding to APWs that are single workers and APWs that are single-earner married couples with children, for the years 1979, 1981, and 1983. The limitations of the sample are due to restrictions imposed by data availability. As Table 1 shows, on a country-by-country basis, changes in the labor income tax rates computed by McKee, Visser, and Saunders coincide with the changes in the effective average tax rates computed here. Nevertheless, these authors’ estimates are generally higher than those computed here. The bias reflects in part the addition of individual capital income tax as part of the labor income tax, and is also an indication of the relative position of the hypothetical APW in each country’s tax schedule and income distribution.

Table 1.Comparison of Average Tax Rates on Labor Income
McKee-Visser-Saunders2
Mendoza-Razin-Tesar1Single worker APWMarried couple APW
Country197919811983197919811983197919811983
Canada32.437.838.043.345.142.741.143.042.7
France63.562.965.766.966.768.857.557.259.7
Germany54.353.554.561.160.560.456.856.457.0
Italy45.445.751.756.359.562.756.359.562.7
Japan26.628.629.240.543.943.735.939.439.9
United Kingdom39.543.245.051.553.454.551.553.454.5
United States32.234.733.547.152.948.640.245.242.6

Including effective average sales tax.

McKee, Visser, Saunders (1986).

Including effective average sales tax.

McKee, Visser, Saunders (1986).

The international studies on capital income taxation by McKee, Visser, and Saunders (1986) and OECD (1991b) are based on a methodology originally developed in the work of King and Fullerton (1984). This method computes rates of taxation on marginal investments as the percentage difference between post- and pre-tax net rates of return on specific investment projects. The pre-tax real rate of return is defined as the value of the marginal rate of return that equates the expected discounted present value of the future stream of after-tax profits of the project with its cost, net of grants and allowances, and after deducting the rate of depreciation. The procedure requires, therefore, that researchers obtain information on the statutory taxes on corporate and individual capital income according to ownership institutions, industries, and form of income (i.e., interest, dividends, or retained earnings), as well as information on application of taxes, credits, and exemptions according to form of financing and accounting of depreciation. Moreover, the computation of real internal rates of return also requires assumptions regarding the expected path of the rate of inflation and the market discount factor.

The tax rates computed in the three studies just mentioned illustrate strengths and weaknesses of the King-Fullerton approach. The tax rates differ very significantly depending on the sector to which investment is going, on whether, within each sector, it is oriented toward equipment, structures, or inventories, on whether it is financed by debt, new share issues, or retained earnings, on whether it is undertaken by firms owned by households subject to personal income taxes or by tax-exempt institutions, and on the assumed inflation and market discount rates. For instance, McKee, Visser, and Saunders show that for the United States in 1983, the tax rate on investments in manufacturing, assuming inflation fixed at 8.3 percent, varies from–137.8 percent, for equipment investments by tax-exempt institutions incurring debt, to 97.1 percent for investments in structures financed by household-owned firms issuing new shares.

While this methodology provides accurate measures of the effective marginal tax on specific investments, which can be compared across industries and across countries, it is nonetheless difficult to introduce into a macroeconomic model for explaining aggregate investment and saving decisions. Moreover, the assumptions of perfect foresight regarding the future paths of profits and prices seem difficult to integrate with the uncertain environment that modern macroeconomic models emphasize.

Stylized Facts of Effective Average Tax Rates

In this section, the empirical regularities that characterize the effective average tax rates and their co-movements with other key macroeconomic aggregates are examined. The analysis serves two purposes. First, it provides some informal evidence on the empirical regularities that distinguish the tax systems across large industrial countries. Second, it gives some insight into the potential empirical relevance of effective average tax rates for macroeconomic modelling. The second goal is accomplished by contrasting the co-movements we find between our estimates of the tax rates and data on macroeconomic variables with basic implications derived from theory. However, the results of this analysis must be interpreted carefully because they are intended only to establish whether effective average tax rates “make sense,” in the sense that they do not produce empirical puzzles, without providing substantial evidence for or against any particular model.

There are three basic theoretical implications regarding the connection between taxes and macroeconomic variables that we examine here. The first two follow from intertemporal equilibrium models of the open economy. In these models, as Frenkel, Razin, and Sadka (1991) explain, the capital income tax distorts savings decisions by taxing the benefits obtained from postponing consumption. An increase in the rate of the capital income tax lowers the intertemporal relative price of consumption, inducing agents to increase current consumption and reduce savings. In contrast, investment should not be significantly affected by capital income taxation to the extent that financial capital is mobile across countries, physical capital is not costly to adjust, and the returns on domestic and foreign investments are taxed uniformly. If there are capital-adjustment costs, capital income taxes affect investment depending on whether it is equity- or debt-financed.11 Hence, we examine whether the capital income tax rate and the savings rate are negatively correlated, and we also study the co-movement between investment and the capital income tax.

The second implication of the neoclassical framework that we examine is that taxes on consumption and labor reduce the price of leisure time relative to consumption. As these two tax rates rise, households substitute consumption for leisure and devote less time to work. Thus, we study whether the sum of the labor and consumption tax rates is negatively correlated with the number of hours worked per worker.12 Finally, we also examine a prediction of equilibrium models of unemployment as that of Pissarides (1985), which has also been examined in the empirical literature on the natural rate of unemployment.13 In Pissarides’ search framework, given tax-free unemployment compensation, firms cannot pass the effect of an increase in the rate of labor income tax entirely to workers, and hence wage costs to firms increase with the tax and result in a decline in profits and vacancies and higher equilibrium unemployment. We examine, then, whether the rate of unemployment is positively related to the labor income tax, particularly in the absence of cyclical effects.

Charts 14 illustrate some important stylized facts of taxation in industrial countries. First, effective average tax rates have fluctuated markedly since 1965 mainly in response to both long-term fiscal reforms and short-term policy changes in statutory taxes, tax credits, and exemptions, and also to some extent in response to cyclical effects affecting the data on tax revenues and the measures of tax bases described earlier.14 While tax rates on consumption and capital income appear to be stationary (except for the tax rate on capital income in Japan), the effective average tax rate on labor income has followed an increasing trend in all countries. Second, cross-country differences in tax rates, particularly labor income tax rates, have narrowed considerably in recent years relative to the late 1960s.

Nevertheless, as of 1988 one can still identify clear differences in the various tax systems, and, in general, it is observed that countries that tax more (less) consumption and labor income tend to tax less (more) capital income. The rate of taxation on consumption is significantly lower in Japan and the United States than in the rest of the countries examined. The tax rates on labor income can be divided into three groups—four countries with a rate between 26 and 28 percent (Canada, Japan, the United Kingdom, and the United States), two with a rate of about 41 percent (Germany and Italy), and one with a rate of nearly 47 percent (France). Similarly, taxes on capital income can also be broken down in three groups. The capital income tax rate is significantly higher, at about 57 percent, in the United Kingdom and Japan than in the other countries.15 In Canada and the United States capital income is taxed at about 40 percent, while in France, Germany, and Italy, that tax rate is around 25–28 percent. A comparison of Charts 3 and 4 suggests also that the mix between corporate and individual capital income taxes has shifted over time in most countries.

Tables 2 and 3 report the arithmetic means of the effective average tax rates in each country and their co-movement with savings, investment, net exports, unemployment, trend unemployment—as a proxy for the natural rate of unemployment—and hours worked.16 These statistics only provide a general idea of how taxes and other macroeconomic variables differ across countries on average, and how they move within each country over time; they must be interpreted with caution because some of the series, in particular the labor income tax rates, do not appear to be stationary in the sample under study. An examination of the co-movement of the tax rates and macroeconomic variables at business cycle frequencies, using filters to separate trend and cyclical components, is undertaken later in this section.

Table 2.Savings, Investment, Net Exports, and Capital Income Tax Rates
Savings/GDP RatioInvestment/GDP RatioNet Exports/GDP RatioCapital Tax Rate
CountryMeanCorr. (tk)1MeanCorr. (tk)1MeanCorr. (tk)Mean
United States0.170.320.180.11−0.010.340.43
United Kingdom0.18−0.230.18−0.370.090.56
Germany0.25−0.850.22−0.690.03−0.110.25
Italy0.21−0.430.21−0.930.950.26
France0.23−0.950.22−0.810.01−0.530.24
Japan0.33−0.450.31−0.580.020.360.33
Canada0.24−0.120.220.110.02−0.240.40
Note: Data are for the period 1965–88, except for Italy (1980–88) and France (1970–88).

Contemporaneous correlation with the capital income tax rate.

Note: Data are for the period 1965–88, except for Italy (1980–88) and France (1970–88).

Contemporaneous correlation with the capital income tax rate.

Table 3.Unemployment, Hours Worked, Consumption Tax, and Labor Income Tax
Unemployment RateTrend Unemployment2Hours4Consumption TaxLabor Income Tax
CountryMeanCorr. (tl)1MeanCorr. (tl)3MeanCorr. (tc+tl)5MeanMean
United Slates6.200.746.300.93104.7−0.765.7724.77
United Kingdom5.260.565.030.60104.8−0.7114.3726.63
Germany3.730.833.650.90105.1−0.9215.6836.45
Italy10.090.959.970.95101.30.6612.4738.27
France8.070.987.830.99102.2−0.8621.4943.49
Japan1.900.941.860.97102.6−0.495.1220.47
Canada7.180.807.140.91104.0−0.7312.3022.30
Note: Data are for the period 1965–88, except for Italy (1980–88) and France (1977–88).

Correlation between the unemployment rate and the labor income tax rate.

Trend defined as the trend component of data filtered using the Hodrick-Prescott filter with the smoothing parameter set at 100.

Correlation between trend unemployment and the labor income tax rate.

Average annual hours in manufacturing (index, 1982 = 100).

Correlation between hours and the sum of the labor income and consumption tax rates.

Note: Data are for the period 1965–88, except for Italy (1980–88) and France (1977–88).

Correlation between the unemployment rate and the labor income tax rate.

Trend defined as the trend component of data filtered using the Hodrick-Prescott filter with the smoothing parameter set at 100.

Correlation between trend unemployment and the labor income tax rate.

Average annual hours in manufacturing (index, 1982 = 100).

Correlation between hours and the sum of the labor income and consumption tax rates.

With regard to time-series co-movements within each country, Table 2 shows that the tax rate on capital income is generally negatively correlated with savings and investment rates, while the correlation between the capital income tax and the net exports-output ratio is positive or negative, depending on the size of the correlations of the tax with investment and savings. Table 3 indicates that the tax rate on labor income moves closely with actual and trend unemployment rates, and hours worked are negatively correlated with the sum of labor and consumption tax rates in all countries except Italy. The time-series correlations between capital income tax and savings, between labor-plus-consumption tax and hours worked, and between labor income tax and unemployment are in line with the theoretical predictions mentioned earlier. The observed negative co-movement between investment and the capital income tax rate is more difficult to interpret. It reflects in part the well-known positive correlation between savings and investment (see Obstfeld (1986)), but it may also be an indication of the degree to which rates of taxation on domestic corporate income and foreign capital income differ, or, assuming capital is costly to adjust, the extent to which the structures of taxation and investment financing vary across countries.

Cross-country comparisons of the mean tax rates in Tables 2 and 3 confirm most of the differences in the structure of the tax systems identified earlier in Charts 14. Cross-country comparisons also suggest that higher savings and investment rates tend to be associated with lower capital income tax rates, higher rates of taxation on labor income tend to coexist with higher unemployment rates, and higher consumption and labor income taxes coincide with less hours worked—with the notable exception of Germany.

Tables 4 and 5 list cyclical co-movements between the tax rates, net exports, savings, investment, hours worked, and unemployment. Cyclical components for the correlations in Table 4 have been obtained using the Hodrick-Prescott filter with the smoothing parameter set at 100, while the correlations in Table 5 correspond to first-differenced data. These cyclical correlations are qualitatively similar to the correlations obtained from the original data, but quantitatively are much weaker. Using the Hodrick-Prescott filter, savings and investment rates, as well as the ratio of net exports to output, are weakly negatively correlated, or uncorrelated, with the capital income tax rate in most countries. Unemployment rates are weakly positively correlated with the labor income tax in three countries (Italy, the United Kingdom, and the United States), while the other countries—except Japan—display almost no cyclical correlation between the two variables. Hours worked are significantly negatively correlated with the consumption-labor tax in the United States and Canada, almost uncorrelated in the United Kingdom, Italy, and France, and positively correlated in Germany and Japan. Table 5 reports similar results using first-differenced data, although the magnitude of some correlation coefficients is noticeably different. Overall, these cyclical co-movement indicators suggest that, while there are no obvious anomalies in the co-movement of tax rates and macroeconomic aggregates during business cycles, the link between the two sets of variables seems stronger at frequencies lower than business cycle frequencies. This is a reasonable result in view of the fact that changes in tax policy need approval of legislative bodies in most countries, and hence tax rates are not likely to fluctuate significantly at business cycle frequencies.

Table 4.Cyclical Correlations of Savings, Investment, Net Exports, Hours Worked, and Unemployment with Effective Average Tax Rates1(Based on Hodrick-Prescott filter)
CountrySavings-Capital TaxInvestment-Capital TaxNet Export-Capital TaxHours Worked-Labor Consumption TaxUnemployment-Labor Tax
United States0.09−0.190.37−0.740.11
United Kingdom−0.19−0.01−0.13−0.010.32
Germany−0.30−0.19−0.040.450.01
Italy0.55−0.600.640.050.15
France−0.800.03−0.73−0.010.07
Japan0.050.36−0.390.67−0.46
Canada−0.17−0.07−0.08−0.27−0.02

Savings, investment, and net exports as a share of GDP. Savings equals GDP minus private and public consumption. All data are detrended using the Hodrick-Prescott filter with the smoothing parameter set at 100. Hours worked are logged prior to detrending. Data cover the period 1965–88, except for Italy (1980–88) and for France (1970–88 for savings, investment, and capital tax rate, and 1977–88 for unemployment, hours worked, and labor and consumption tax rates).

Savings, investment, and net exports as a share of GDP. Savings equals GDP minus private and public consumption. All data are detrended using the Hodrick-Prescott filter with the smoothing parameter set at 100. Hours worked are logged prior to detrending. Data cover the period 1965–88, except for Italy (1980–88) and for France (1970–88 for savings, investment, and capital tax rate, and 1977–88 for unemployment, hours worked, and labor and consumption tax rates).

Table 5.Cyclical Correlations of Savings, Investment, Net Exports, Hours Worked, and Unemployment with Effective Average Tax Rates1(Based on first-differenced data)
CountrySavings-Capital TaxInvestment-Capital TaxNet Export-Capital TaxHours Worked-Labor Consumption TaxUnemployment-Labor Tax
United States−0.12−0.240.17−0.620.16
United Kingdom−0.100.05−0.10−0.140.34
Germany−0.18−0.170.020.47−0.30
Italy0.71−0.710.850.250.63
France−0.810.26−0.79−0.030.28
Japan0.090.33−0.280.48−0.22
Canada−0.230.08−0.27−0.21−0.07

Savings, investment, and net exports as a share of GDP. Savings equals GDP minus private and public consumption. All data are detrended by first differencing. Hours worked are logged prior to detrending. Data cover the period 1965–88, except for Italy (1980–88) and for France (1970–88 for savings, investment, and capital tax rate, and 1977–88 for unemployment, hours worked, and labor and consumption tax rates).

Savings, investment, and net exports as a share of GDP. Savings equals GDP minus private and public consumption. All data are detrended by first differencing. Hours worked are logged prior to detrending. Data cover the period 1965–88, except for Italy (1980–88) and for France (1970–88 for savings, investment, and capital tax rate, and 1977–88 for unemployment, hours worked, and labor and consumption tax rates).

The stylized facts documented above provide some crude evidence on the extent to which effective average tax rates help explain the behavior of savings, investment, unemployment, hours worked, and the balance of trade. We try to formalize this evidence by applying panel data econometric techniques that combine the time-series and cross-sectional information on tax rates and macroeconomic variables. The data is pooled by stacking the time series of each of the seven countries in the sample, and then we estimate basic pooled (total), between means, fixed effects, random effects, and country independent models. The regressions for which each model is estimated are (1) the savings rate on the capital income tax rate; (2) the investment rate on the capital income tax rate; (3) the ratio of net exports to output on the capital income tax rate; (4) the rate of unemployment on the labor income tax rate; and (5) the index of hours worked on the sum of the labor income tax and the consumption tax. The models were also estimated using a time trend to account for the problem of non-stationarity in some of the variables involved—particularly in the case of the labor income tax rates. The basic statistics describing the results of these tests are presented in Tables 615. Table 16 reports additional information combining cross-sectional and time-series data by computing co-movements of some of the time series in terms of deviations from the average for the group of seven in each year.

Table 6.Panel Data Tests: Regression of Savings Rate on Capital Income Tax Rate

(Time trend excluded)1

ModelInterceptSlopeF-Test AgainstHausman TestR2SSR
TotalIndependent
Total0.301−0.192129.52*0.2110.325
(25.670)*(−6.345)*12,134
Means0.292−0.1800.0160.013
(4.613)*(−1.048)
Fixed Effects−0.102169.85*11.653*0.0890.039
(−4.619)*6,1406,134
Random Effects0.265−0.1030.00.1010.041
(14.159)*(−4.634)*1
Independent
United States0.1010.1700.0610.006
(2.183)(1.578)
United Kingdom0.200−0.0320.0110.004
(12.097)*(−1.121)
France0.344−0.5030.8930.001
(35.100)*(−12.283)*
Germany0.393−0.5850.7040.003
(19.910)*(−7.468)*
Italy0.2400.1160.0730.003
(10.29)*(−1.276)
Canada0.252−0.0400.0130.003
(8.532)*(−0.549)
Japan0.359−0.0940.1680.009
(26.240)*(−2.379)*

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 7.Panel Data Tests: Regression of Investment Rate on Capital Income Tax Rate

(Time trend excluded)1

ModelInterceptSlopeF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.282

(26.810)
*−0.159

(−5.848)
*87.32*

12,134
01840.262
Means0.274

(4.959)
*−0.142

(−0.957)
0.097
Fixed Effects−0.126

(−5.708)
*131.57*

6,140
7.339*

6,134
0.1480.040
Random Effects0.268

(15.830)
*0.126

(−5.675)
*0.0

1
0.1630.041
Independent
United States0.170

(6.858)
*0.031

(0.536)
0.002
United Kingdom0.212

(13.787)
*−0.050

(−1.849)
0.0950.003
France0.316

(18.921)
*−0.393

(−5.629)
*0.6300.003
Germany0.353

(11.890)
*−0.528

(−4.480)
*0.4530.006
Italy0.374

(5.155)
*−0.622

(−6.483)
*0.8370.007
Canada0.203

(4.973)
0.054

(0.539)
0.005
Japan0.360

(25.155)
*−0.140

(−3.379)
*0.3120.010

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 8.Panel Data Tests: Regression of Net Exports-Output Ratio on Capital Income Tax Rate

(Time trend excluded)1

ModelInterceptSlopeF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.019

(4.324)
*−0.033

(−2.974)
*8.692*

12,134
0.0510.044
Means0.018

(1.221)
−0.037

(−0.900)
0.001
Fixed Effects−0.024

(1.318)
13.982*

6,140
2.502*

6,134
0.027
Random Effects0.002

(0.243)
0.011

(0.650)
3.240

1
0.029
Independent
United Slates−0.068

(−1.919)
0.139

(1.687)
0.0740.004
United Kingdom−0.011

(−0.497)
0.017

(0.430)
0.007
France0.028

(2.671)
*−0.110

(−2.543)
*0.2330.001
Germany0.039

(1.456)
−0.057

(−0.524)
0.005
Italy−0.133

(−8.304)
*0.506

(8.109)
*0.8900.000
Canada0.049

(1.466)
−0.095

(−1.137)
0.0120.004
Japan−0.001

(−0.159)
0.046

(1.832)
0.0920.004

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 9.Panel Data Tests: Regression of Unemployment Rate on Labor Tax Rate

(Time trend excluded)1

ModelInterceptSlopeF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.756

(0.851)
0.160

(5.380)
*30.753*

12,134
0.1601275.4
Means1.870

(0.470)
0.132

(1.019)
0.01033.6
Fixed Effects0.476

(12.440)
*29.231*

6,140
4.623*

6,134
0.501410.1
Random Effects−7.479

(−5.032)
*0.445

(11.643)
*120.61*

1
0.474448.9
Independent
United States−2.602

(−1.505)
0.355

(5.143)
*0.52532.5
United Kingdom−17.154

(−2.427)
*0.842

(3.184)
*0.284195.0
France−16.849

(−20.69)
*0.575

(28.577)
*0.9783.3
Germany−18.891

(−5.795)
*0.620

(6.974)
*0.67456.8
Italy−9.757

(−4.035)
*0.519

(8.223)
*0.8931.6
Canada−3.943

(−2.190)
*0.499

(6.268)
*0.62549.6
Japan−1.125

(−4.634)
*0.148

(12.654)
*0.8741.0

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 10.Panel Data Tests: Regression of Hours Worked on the Sum of the Consumption and Labor Tax Rates

(Time trend included)1

ModelInterceptSlopeF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total106.2

(95.29)
*−0.059

(−2.218)
*19.661*

12,127
0.0272122.1
Means104.9

(51.27)
*−0.032

(−0.692)
12.1
Fixed Effects−0.685

(−9.350)
*17.005*

6,133
13.063*

6,127
0.3651200.9
Random Effects119.1

(42.86)
*−0.366

(−6.103)
*57.521*

1
0.6101568.8
Independent
United States119.7

(43.61)
*−0.492

(−5.512)
*0.56046.2
United Kingdom138.4

(19.50)
*−0.821

(−4.759)
*0.485192.3
France160.8

(14.79)
*−0.903

(−5.401)
*0.71930.0
Germany195.4

(23.58)
*−1.731

(−10.913)
*0.837135.5
Italy77.8

(7.66)
*0.463

(2.317)
*0.35328.5
Canada118.3

(41.32)
*−0.414

(−5.033)
*0.51453.4
Japan115.7

(23.17)
*−0.511

(−2.645)
*0.207256.7

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 11.Panel Data Tests: Regression of Savings Rate on Capital Income Tax Rate

(Time trend included)1

ModelInterceptSlopeTrendF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.389

(8.890)
*−0.182

(−6.031)
*−0.001

(−2.084)
108.84*

18,127
0.2280.316
Means1.030

(1.519)
−0.284

(−1.470)
−0.009

(−1.093)
0.0530.010
Fixed Effects−0.015

(−0.676)
−0.002

(−6.972)
*228.18*

6,139
5.439*

12,127
0.3200.029
Random Effects0.352

(15.653)
*−0.019

(−0.840)
−0.001

(−6.739)
*0.0

2
0.3140.031
Independent
United States0.262

(7.356)
*0.139

(2.237)
−0.002

(−6.783)
*1.6920.002
United Kingdom0.244

(8.419)
*0.013

(0.355)
−0.001

(−1.805)
0.1030.003
France0.442

(16.269)
*−0.306

(−5.016)
*−0.002

(−3.749)
*0.9390.001
Germany0.404

(15.773)
*−0.527

(−4.643)
*0.000

(−0.780)
0.6970.003
Italy0.442

(8.034)
*0.177

(1.884)
−0.003

(−3.782)
*0.6800.000
Canada0.313

(7.162)
*−0.077

(−1.067)
−0.001

(−1.823)
0.0670.002
Japan0.527

(4.207)
*0.101

(0.677)
−0.003

(−1.352)
0.1990.008

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 12.Panel Data Tests: Regression of Investment Rate on Capital Income Tax Rate

(Time trend included)1

ModelInterceptSlopeTrendF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.375

(9.603)
*−0.149

(−5.510)
*−0.001

(−2.466)
*72.82*

18,127
0.2110.252
Means0.752

(1.193)
−0.211

(−1.173)
−0.006

(−0.762)
0.009
Fixed Effects−0.041

(−1.773)
−0.001

(−6.834)
*174.04*

6,139
3.491*

12,127
0.3580.029
Random Effects0.354

(16.857)
*−0.044

(−1.9101)
−0.001

(−6.640)
*0.0

2
0.3570.031
Independent
United States0.195

(5.937)
*0.026

(0.452)
−0.000

(−1.161)
0.002
United Kingdom0.261

(10.087)
*0.002

(0.0561)
−0.001

(−2.278)
*0.2400.003
France0.506

(12.589)
*−0.012

(−0.135)
−0.004

(−4.890)
*0.8430.001
Germany0.423

(13.903)
*−0.173

(−1.282)
−0.002

(−3.676)
*0.6520.004
Italy0.585

(9.890)
*−0.314

(−3.113)
*−0.003

(−3.687)
*0.9420.000
Canada0.325

(5.922)
*−0.020

(−0.218)
−0.001

(−2.904)
*0.2290.004
Japan0.532

(4.044)
*0.059

(0.378)
−0.003

(−1.313)
0.3340.009

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 13.Panel Data Tests: Regression of Net Exports-Output Ratio on Capital Income Tax Rate

(Time trend included)1

ModelInterceptSlopeTrendF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total0.014

(0.837)
−0.034

(−2.978)
*0.000

(0.316)
9.082*

18,127
0.0480.044
Means0.279

(2.151)
−0.074

(−1.992)
−0.003

(−2.012)
0.3600.001
Fixed Effects0.025

(1.146)
0.000

(−0.083)
13.859*

6,139
4.562*

12,127
0.027
Random Effects−0.001

(−0.090)
0.882

(0.464)
0.000

(0.243)
2.169

2
0.029
Independent
United States0.067

(3.324)
*0.113

(3.221)
*−0.002

(−10.107)
*0.8340.001
United Kingdom−0.017

(−0.393)
0.011

(0.205)
0.000

(0.153)
0.007
France−0.064

(−2.052)
−0.293

(−4.200)
*0.002

(3.051)
*0.4840.001
Germany−0.019

(−0.649)
−0.354

(−2.716)
*0.001

(3.183)
*0.2700.003
Italy−0.143

(−2.057)
0.492

(4.147)
*0.000

(0.142)
0.8720.001
Canada−0.012

(−0.232)
−0.057

(−0.685)
0.001

(1.572)
0.0740.003
Japan−0.005

(−0.056)
0.042

(0.425)
0.000

(0.040)
0.0490.004

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 14.Panel Data Tests: Regression of Net Unemployment Rate on Labor Tax Rate

(Time trend included)1

ModelInterceptSlopeTrendF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total−19.581

(−8.758)
*0.021

(0.746)
*0.315

(9.573)
*31.793*

18,127
0.481781.4
Means−52.044

(−1.870)
−0.035

(−0.263)
0.756

(1.950)
0.36217.2
Fixed Effects0.010

(0.143)
0.294

(7.396)
*38.345*

6,139
11.363*

12,127
0.639294.3
Random Effects−17.412

(−10.188)
*0.023

(0.395)
0.288

(8.178)
*0.119

2
0.657309.9
Independent
United States−1.538

(0.356)
0.606

(2.427)
*−0.135

(−1.045)
0.52730.9
United Kingdom−29.021

(−7.052)
*−0.001

(−0.008)
0.449

(7.440)
*0.79453.6
France−19.922

(−4.514)
*0.482

(3.638)
*0.086

(0.709)
*0.9783.2
Germany−25.246

(−11.127)
*−0.313

(−1.916)
0.528

(6.061)
*0.87620.7
Italy−28.576

(−8.369)
*0.130

(1.798)
0.401

(5.776)
*0.9810.2
Canada−16.804

(−4.053)
*−0.046

(−0.260)
0.327

(3.324)
*0.74232.5
Japan−4.145

(−3.071)
*0.011

(0.174)
0.076

(2.269)
*0.8940.8

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 15.Panel Data Tests: Regression of Hours Worked on the Sum of the Consumption and Labor Tax Rates

(Time trend included)1

ModelInterceptSlopeTrendF-Test AgainstHausman TestR¯2SSR
TotalIndependent
Total138.3

(56.62)
*0.058

(2.986)
*−0.475

(−13.763)
*18.053*

18,120
0.587894.4
Means143.7

(16.42)
*0.059

(2.014)
*−0.544

(−4.458)
*0.7712.0
Fixed Effects0.180

(1.381)
−0.522

(−7.555)
*1.453

6,132
24.782*

12,120
0.553838.9
Random Effects138.3

(55.3)
*0.057

(2.799)
*−0.474

(−13.389)
*3.995

2
0.546890.2
Independent
United States111.8

(51.09)
*−1.469

(−8.372)
*0.493

(5.875)
*0.82617.5
United Kingdom145.6

(31.82)
*−0.043

(−0.258)
*−0.510

(−5.990)
*0.80071.1
France166.8

(13.93)
*−0.282

(−0.490)
−0.561

(−1.125)
0.72626.3
Germany172.8

(36.96)
*−0.120

(−0.604)
−0.803

(−8.810)
*0.96428.9
Italy39.8

(1.03)
−0.120

(−0.200)
0.806

(1.022)
0.35724.3
Canada125.0

(46.61)
*0.047

(0.374)
−0.296

(−4.199)
*0.72329.0
Japan161.9

(31.94)
*2.403

(7.971)
*−1.580

(−10.045)
*0.85744.22

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Numbers in parentheses are t-statistics. Numbers in bold are degrees of freedom for numerator and denominator of F-tests or for the Hausman Test of the fixed versus random effects models. An asterisk denotes statistical significance at the 5 percent level.

Table 16.Co-Movement Between Macroeconomic Variables and Tax Rates(Based on deviations from cross-sectional means)
CountrySavings-Capital TaxInvestment-Capital TaxNet Exports-Capital Tax
United States0.233−0.6190.664
United Kingdom0.3830.0470.259
Germany−0.5140.053−0.547
Italy0.508−0.6040.874
France−0.630−0.208−0.458
Japan0.092−0.3190.591
Canada−0.810−0.550−0.417

The results of the panel tests indicate that there is statistically significant evidence of a negative relationship between the savings rate, or the investment rate, and the capital income tax rate, and between hours worked and the consumption-labor tax, as well as a positive link between unemployment and the labor income tax. These effects are estimated with more precision in the total regressions involving the time series of the seven countries, while regressions based on country means generally produce slope coefficients that are not significantly different from zero. Both fixed effects (common slope coefficients, fixed intercepts) and random effects (common slopes, random intercepts) models generally produce statistically significant coefficients with the expected signs when the time trend is ignored, but in the regressions with time trends the standard errors are too large to reject the hypothesis that the slope coefficients are not zero. Thus, the panel tests also support the view that the link between macroeconomic variables and tax rates is stronger at low frequencies. Moreover, given the differences in tax structures discussed above, it is not surprising that most of the hypothesis tests that evaluate whether the slope coefficients, the intercepts, or all parameter estimates are equal across countries produce negative results. Hence, while the pooled data indicate that increases in the capital tax rate have adverse effects on savings and investment, increases in the consumption or labor income tax reduce hours worked, and increases in the labor income tax result in an increase in unemployment, the magnitude of these effects seems to differ across countries.

The results of the independent model regressions reported in Tables 615 give support to the argument that the effects of changes in taxes on macroeconomic variables differ significantly across countries. Note that in each of these regressions, the slope coefficients are statistically different from zero only when the sign of the coefficient is as predicted by theory—except in the cases of Italy in Table 6 and Japan in Table 15. Thus, effective average tax rates produce statistically significant co-movements with savings, hours worked, and unemployment that are consistent with basic theoretical principles. Moreover, in some countries the tax rates alone are sufficient to explain a large fraction of the observed movements in savings, hours worked, and unemployment. This is particularly the case of the capital income tax rate as an explanatory variable of savings in France, Germany, and Italy, and the labor income tax as an explanatory variable of unemployment in the United Kingdom and the United States, and the sum of the labor and consumption taxes as an explanatory variable of hours worked in the United States.

The results of the independent regressions for the United States are of particular interest in view of the current discussion on the possibility of increasing tax rates on consumption or labor income in order to reduce the fiscal deficit. The international comparison of tax rates discussed earlier in this section indicated that consumption and labor taxes are significantly lower in the United States than in the rest of the large industrial countries (except Japan), so that potential tax increases would tend to harmonize the U.S. tax rates with those of other countries. The econometric analysis provides insight into some of the implications that would follow from these tax increases. In particular, we find that an increase of 1 percentage point in the labor income tax may result in an increase in the unemployment rate of about ⅓ of 1 percentage point (see Table 9), and that an increase of 1 percentage point in either consumption or labor income taxes may induce a reduction in the index of hours worked of between ½ to 1½ points (see Tables 10 and 15). All the coefficient estimates that link the tax rates to unemployment and hours worked in the United States are statistically significant, the explanatory power of the regressions ranges from 53 percent to 83 percent, and the Durbin-Watson statistics reject the hypothesis of first-order serial autocorrelation of the residuals when the time trend is included. It must be noted, however, that these results are not an indication of the welfare effects of the tax increases examined, but merely a rough estimate of their partial effects on some of the elements that affect the behavior of labor markets.

The clear relationship between the tax rates and savings, hours worked, and unemployment, and the fact that the relationship seems stronger at lower frequencies is clearly illustrated in Charts 68 for the case of Germany. Chart 6 shows how, over the period 1965–88, the savings and investment rates in Germany fell in conjunction with an increase in the capital income tax rate. On a yearly basis, however, there are episodes during which the capital income tax increased and savings also increased. Chart 7 illustrates a similar point for the rate of unemployment and the labor income tax and Chart 8 for the index of hours worked and the sum of the labor and consumption tax rates.

Chart 6.Germany: Savings, Investment, and Capital Income Tax

(In percent)

Chart 7.Unemployment and Labor Income Tax

(In percent)

Chart 8.Average Hours Worked and Consumption-Labor Income Tax Rate1

1 Average hours worked is an index number; the tax rate is in percent.

To conclude, Table 17 reports some of the cyclical properties of tax revenues based on Hodrick-Prescott filtered data. We observe that the revenue of all three taxes is more variable than output in each country, and that capital income tax revenue tends to fluctuate more than the revenue from labor income tax and the consumption tax. Revenues are generally procyclical and uncorrelated, or weakly negatively correlated, with net exports. These results suggest that, while our measures of effective average tax rates may be affected by cyclical noise, as explained before, the fact that tax revenues and tax bases tend to move together over the business cycle contributes to minimize that noise.

Table 17.Variability and Co-Movement of Tax Revenues in Industrial Countries1
Sales Tax RevenueLabor Income Tax RevenueCapital Income Tax RevenueOutput
CountryStandard dev.Output corr.Trade balance corr.Standard dev.Output corr.Trade balance corr.Standard dev.Output corr.Trade balance corr.Standard dev.
United Slates3.040.11−0.063.740.35−0.075.830.74−0.192.30
United Kingdom4.86−0.380.354.71−0.240.184.71−0.38−0.122.03
Germany4.490.75−0.574.530.84−0.115.920.51−0.023.08
France2.660.59−0.082.540.17−0.063.940.37−0.601.93
Italy4.090.54−0.012.450.130.363.97−0.340.602.33
Japan6.490.810.043.520.75−0.169.090.83−0.283.98
Canada5.710.080.095.220.12−0.234.950.690.632.85

Data are annual observations for the period 1965-88 (except 1970-88 for France and 1980-88 for Italy), expressed in per capita terms, logged, and detrended using the Hodrick-Prescott filter with the smoothing parameter set at 100. Measures of tax revenue were computed using revenue figures from OECD (1990). Output and revenue figures were deflated using the private consumption deflator. The detrended trade balance is equal to the detrended ratio of net exports to output.

Data are annual observations for the period 1965-88 (except 1970-88 for France and 1980-88 for Italy), expressed in per capita terms, logged, and detrended using the Hodrick-Prescott filter with the smoothing parameter set at 100. Measures of tax revenue were computed using revenue figures from OECD (1990). Output and revenue figures were deflated using the private consumption deflator. The detrended trade balance is equal to the detrended ratio of net exports to output.

Conclusion

This paper presented a method for computing effective average rates of taxation on consumption and the income derived from capital and labor based on aggregate data from revenue statistics and national income accounts. Following recent work by Lucas (1990) and (1991) and Razin and Sadka (1993), we constructed estimates of the tax rates that represent the wedges distorting optimal plans in a representative agent framework by calculating percentage differences in measures of aggregate post- and pre-tax incomes and prices. The method was used to compute time series of the three tax rates for the group of seven largest industrial countries covering the period 1965–88. The potential applicability of the resulting tax rates in the design of macroeconomic models of fiscal policy was examined by contrasting the results of this study with existing estimates of effective marginal tax rates, as well as by exploring the relationship between the tax rates and savings, investment, net exports, hours worked, and unemployment.

The comparison between the effective average tax rates computed here and available estimates of effective marginal tax rates showed that, while the levels of the taxes differ, the trends are very similar. Moreover, average tax rates are within the range of existing estimates of marginal tax rates, and a large fraction of the difference between the two can be attributed to the treatment of tax credits and exemptions and the treatment of consumption taxes. The differences between the two sets of estimates are minimal when the effective average labor income tax is adjusted to incorporate sales taxes, and the resulting effective tax is compared with estimates of marginal tax rates based on tax returns data.

The empirical analysis undertaken here illustrates important trends and differences in the structure of the tax systems among industrial countries. While labor, capital, and consumption taxes have fluctuated noticeably in response to changes in statutory tax schedules and policies regarding credits and exemptions, capital and consumption taxes have not exhibited a noticeable trend in general; the rate of taxation on labor income has increased over time in all of the countries studied. The rates of indirect taxation and labor income tax tend to be higher in European countries relative to Japan and the United States, while the effective average tax rates on capital income in the United States have been higher than in other large industrial countries—except the United Kingdom and, in recent years, Japan. Notwithstanding significant differences in tax systems, tax rates have tended to converge over the last twenty years for groups of countries in the sample—particularly in the case of consumption taxes in European countries (except France), labor income taxes in North America, Japan, and the United Kingdom, and capital income taxes in Germany, Italy, and France, and in the United States and Canada.

The statistical analysis relating effective average tax rates to macroeconomic variables provided evidence suggesting that these measures of tax rates may be useful for macroeconomic modeling. In particular, the effective average tax rate on capital income is negatively related to savings rates, and the consumption and labor income tax rates are negatively correlated with the number of hours worked, as predicted by neoclassical equilibrium models. Moreover, the level and trend of the rate of unemployment are positively correlated with the tax on labor income, as predicted by models of equilibrium unemployment or the “natural rate.” These relationships are stronger in panel data tests that combine time-series and cross-sectional information, but they remain strong even for time series of several individual countries. These empirical regularities were also documented using data that were adjusted and unadjusted for time trends. The relationships between macroeconomic variables and the tax rates were found to be generally stronger at low frequencies relative to business cycle frequencies.

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These authors start their analysis by examining the details of the Israeli tax laws, including credits and exemptions, and the effects of the inflation tax on measures of effective marginal tax rates on capital income similar to those of King and Fullerton (1984) and Auerbach (1987).

The average income tax rate on corporate capital can be computed in a similar manner by dividing the income tax bill of all corporate enterprises by the operating surplus of the corporate sector.

For earlier studies of this issue see Seater (1982), Barro and Sahasakul (1983), and Wright (1969).

Joines (1981) also constructed estimates of the effective marginal tax rate on capital income by computing a weighted average of proportional and nonproportional capital income taxes. The nonproportional tax is assumed to be identical to the federal personal income tax, and the proportional taxes include sales taxes, property taxes, corporate income taxes, and state and local income taxes. Joines’s estimates are slightly higher than those reported in the paper for the effective average tax rate on capital income, but the two series display similar trends. The difference between the two estimates is minimal if the average sales tax is added to the average capital income tax.

The APW income is the average of earnings of production workers in the manufacturing sector.

In general, assuming taxes are constant over time, it is only when firms retain profits and issue equity that investment would be independent of the tax structure (see Frenkel, Razin, and Sadka (1991), Chapter 5).

Note that the two co-movements identified in this paragraph emphasize only substitution effects resulting from a specific tax adjustment. The equilibrium co-movements observed in the data, however, reflect the outcome of income and substitution effects that result not only from changes in one tax rate, but also from other exogenous variables—such as other tax changes, productivity disturbances or terms of trade shocks. For a formal analysis of this issue see Mendoza and Tesar (1992).

See, for example, Adams and Coe (1990).

Fluctuations in the corporate income tax rate of the United Kingdom are particularly notorious. The sharp increases following the oil price shocks reflect increases in tax revenue from the petroleum revenue tax and the supplementary petroleum duty (see OECD (1990), p. 136), as well as declines in the aggregate operating surplus of corporations due to the recession induced by those shocks. Nevertheless, the corporate income tax during the period 1973–82 was centered around 52 percent, which was in line with the statutory General Corporate Tax prevailing at that time.

The striking pattern of the average capital income tax rate in Japan, which unlike in the other countries has increased in a sustained manner since 1965, is an interesting fact to examine by itself in light of the impressive growth performance of the country over the same period.

Data on national accounts aggregates were obtained from OECD (1991a) and data on hours worked, which correspond to an index of hours worked per employee in the manufacturing sector, were obtained from Bureau of Labor Statistics (United States (1992b)).

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