3. Recent trends in tax reforms.
Over the last years, Member States have carried out important reforms of their tax systems. These
reforms were driven by several factors. First, high unemployment rates and low participation rates
represent a loss of human capital and create social tensions. European Labour markets are distorted by
taxes and Member States have sought to create a more employment-friendly labour taxation. Doing this,
they have also faced the difficulty of finding alternative tax bases to finance their expenditures. Second,
globalisation has increased the mobility of capital and of some categories of workers. This increased
mobility has fuelled fears of adverse consequences of a shift from mobile to immobile sources of
taxation. Third, Member States have done efforts to rationalise and simplify their tax systems. This
potentially brings economic benefits but also bring forward the question of a possible trade-off between
efficiency and fairness. Finally, globalisation and ageing have raised the issue of the financing of the
European Social Model(s). In particular, the constraints imposed by these challenges make it necessary to
find alternative and robust tax bases. Although it goes beyond the scope of this paper to analyse each and
any tax reform, this section will review these four issues in turn, illustrating them with concrete reforms.
3.1. Employment-friendly labour taxation.
Taxation is a source of distortion in the labour markets and will affect both the supply of and the demand
for labour^18. The impact taxes on wages and employment depends on the interactions between labour
supply and demand, labour market structure and the institutional design such as the wage bargaining
process. Taxes and social security contributions drive a wedge between the cost for the employer and the
net compensation received by the employee. Although theoretically such tax can increase or decrease
labour supply, depending on which of the income and substitution effect dominates, empirical evidence
points to a negative impact of labour taxes, albeit with different magnitude for different groups of
workers. In particular, the effect seems largest for the second member of the household and for lone-
parent families. In parallel to the effect of labour taxation on labour supply, taxes and social security
contributions, to the extent they are reflected in higher labour costs will also decrease labour demand as
costs increase.
Figure 9 - Evolution of the components of labour taxation in % GDP 1995-2004.-6.0-5.0-4.0-3.0-2.0-1.00.01.02.03.0PLEESI IE SKLVNLFI LUHUDKDE
EU-25ESBECYATIT SELT UKFRCZPT ELMT% GDPPersonal Income taxes SSC employees SSC employers totaln.a.(^18) See Carone and Salomaki (2001) for a review.