Tax and fiscal policy after the COVID-19 crisis

This report, originally prepared for the finance ministers and central bank governors of the G20 at the request of the Italian presidency, examines the challenges and opportunities of developing strategies for state fiscal policy.

The COVID-19 pandemic has led to a global health crisis and provoked a sharp decline in economic activity.  Rapid and consistent policy measures have contributed to economic recovery, and global GDP is in the process of recovering at its pre-pandemic level. The political response to the COVID-19 crisis included significant financial support for businesses and households, which prevented an even more substantial reduction in employment, income and production.

In addition to the impact of the pandemic on public finances, countries have faced many long-term structural problems.

As most of the G20 countries go through the recovery phase, governments have the opportunity to conduct a fundamental reassessment of their tax and spending policies together with their overall fiscal base.

Economic and social trends forming public finances. A wide range of long-term structural trends affects the functioning of the economy and society around the world. Structural trends include slowing productivity growth, accelerating digitalization, automation and artificial intelligence, rising inequality, an ageing population, changes related to globalization and mobility, climate change and environmental degradation, as well as increasing health risks.

Economic growth is slowing down

Productivity growth has declined in most G20 countries over the past decades. Possible reasons for this slowdown include the disappointing benefits of recent waves of innovation, to some extent due to the costs of adaptation and insufficient dissemination of new technologies and innovations between firms; reduced business dynamism and the redistribution of resources; and an increase in the level of education.

Governments should undertake ambitious structural reforms to accelerate potential growth. The sequence of reforms will be crucial to accelerate the economic recovery, which implies the start of reforms that do not reduce aggregate demand shortly and work exceptionally well during periods of economic downturn.

Public investments can also support long-term growth if they allow the accumulation of productive capital. This, in particular, applies to investments in public infrastructure in digital networks, transport and energy, as well as in education and healthcare. In this context, the initiatives of the European Union and the United States are welcomed.

Accelerating digitalization

COVID-19 has helped accelerate the digitalization of the economy. The critical challenge of digitalization is that digital skills are crucial in a more digital world, increasing the importance of public spending on education and lifelong learning. Digitalization also affects workers due to the "gig economy" growth, which offers flexible business models but can lead to tax distortions and gaps in social protection systems.

Finally, the closure of schools during the pandemic also revealed persistent gaps in the access, quality and use of digital resources for teaching children and students, which requires funds to increase the level of transition to digital technologies.

Fiscal policy needs to adapt to the digitalization of the world, which imposes new burdens and restrictions on social protection systems and income tax bases. Digitalization provides opportunities for progress that fiscal policy can and should exploit, as it will require investments in infrastructure and skills while at the same time ensuring more efficient public administration and stricter compliance with tax requirements. (big data, for example, is increasingly being used by tax administrations to combat tax fraud).

Rising inequality

Growing inequality in various economic and social dimensions increases pressure on state social programs and undermines growth and political stability. The G20 emerging market economies still account for almost half of the world's people living in poverty.

One of the reasons for this is high consumer price inflation. Extreme inflation in education, energy, healthcare and housing has exacerbated limited opportunities for social mobility. The transition to low-carbon technologies will potentially cause problems with energy availability in the short term, particularly for low- and middle-income households.

For example, changes in inheritance taxation, such as limiting generous and regressive tax benefits, may partially solve the problem of wealth inequality while increasing income for additional social spending.

In particular, the inclusion of non-standard forms  in the coverage of traditional social protection systems will strengthen equality. Governments of several G20 and OECD countries have also recently raised income taxes and introduced wealth taxes for the highest-paid and wealthiest households to increase income.

Tax policy should also reflect current problems and progress in international cooperation in the field of taxation.

Population aging

In most G20 countries, the population is ageing, mainly in high-income countries, as a result of a decrease in fertility and an increase in life expectancy. According to the long-term forecasts of the OECD, the average OECD country will need an increase in structural income by 8 percentage points of GDP by 2060 to stabilize public debt ratios.

One of the most effective ways to mitigate future financial pressures caused by an ageing population would be to implement labor market policies and state pension programs that would increase employment and extend service life.

Environmental sustainability and climate change require immediate changes. Mitigating the effects of climate change and the associated adverse risks requires urgent action across many policy areas, with taxes and government spending playing a pivotal role. 

• There is a need for effective pricing of harmful emissions and polluting activities through taxes or emission control systems and emission permits trading.
• Fiscal policy can directly support environmental sustainability through tax incentives for R&D, direct grants, government research, and early-stage development support.
• Compensation packages are needed to mitigate the negative impact on poorer households, affected regions and small businesses.
  
  

Tax reform for inclusive and sustainable economic growth.

After the COVID-19 crisis rethinking their approach to public finance, countries will need to adapt their tax policies to consider structural trends and challenges. Countries and policymakers need to reassess their tax systems and previous tax policy recommendations to ensure that they consider the changing economic and social landscape.

Tax systems can simultaneously raise revenue by helping to address the problems associated with low productivity growth and growing inequality in an environment where debt levels have increased significantly due to the COVID-19 crisis.

Increasing the formalization of business and the labor market will be crucial for increasing the revenue of public spending in general and social protection systems in particular, as well as the revision of ineffective provisions on tax expenditures. Finding ways to increase social security contributions and health taxes to improve the financing of health systems should also be a priority.

Revision of the criteria for the development of tax policy

Tax policy can create contradictory incentives or consequences for equity. For example, in the context of addressing climate change, some countries have introduced R&D tax incentives for green investments or subsidized the insulation of buildings while continuing to provide subsidies for fossil fuels and tax pollution at a rate lower than social costs. While some countries that have raised carbon prices continue to provide tax breaks for the use of official cars or tax diesel fuel more advantageously than gasoline.

Concerning personal income, some countries have raised personal income tax rates at the top of the income distribution while at the same time providing generous and highly regressive tax expenditures that benefit high-income individuals.

The structural trend towards a further increase in inequality requires an improvement in the redistributive capacity of the tax and transfer system. The tax system should consider forms of inequality that go beyond the standard concepts of horizontal and vertical equality to include a more explicit emphasis on equality of opportunity, gender and racial equality, intergenerational equality, regional equality, and equality between countries.

Taxes and capital investments

Earlier studies linking tax structures to economic activity highlighted the negative impact of taxes on capital and labor income compared to other tax categories. Studies have also shown that the transition from direct taxes to indirect taxes, such as taxes on real estate or consumption, contributes to growth.

In response to the financial and economic crisis of 2008/9, many OECD and G20 countries increased their statutory VAT/GST rate to receive more tax revenue.

Recent studies have shown that the expansion of the VAT base due to fewer reduced rates and exemptions contributes to higher long-term growth than an increase in the standard rate.

The influence of tax structures may have changed as the economy has developed in recent decades. Key trends include the expansion of digitalization, low-interest rates, an increase in the importance of intangible assets and an increase in market concentration.

Prolonged periods of low-interest rates may have implications for developing tax policies that stimulate growth since low rates can reduce the difference between accelerated and standard depreciation.

The international tax landscape is developing rapidly, as evidenced by the steady decline in statutory income tax rates and the expansion of tax benefits.

The average statutory corporate income tax (CIT) rate in OECD countries has fallen from more than 32% in 2000 to about 23% in 2020. A similar trend is observed in a sample of more than 90 developing and developed countries over the same period, reducing the average CPN rate from about 28% to just below 21%.

Taxes and labor market participation

After the COVID-19 crisis and in the context of an ageing society, it is crucial to maintain participation in the labor market, especially among people with low incomes and low levels of attachment to the labor market. Labor taxes can have potentially significant consequences for both the number of jobs and their quality, especially in the case of low-productivity workers.

In particular, in recent decades, the share of social insurance contributions (SSC) has increased as a share in the tax structure. The transition from SSC to personal income tax or the introduction of lower SSC rates for lower incomes can positively impact the activation of the labor market.

Policymakers should develop a labour tax burden to encourage work and carefully consider its impact on informal workers, women and low-skilled workers.

Taxes and productivity

Supporting productivity growth through productivity diffusion, business dynamics, and investments in intangible assets is crucial for policymakers.

Investments in intangible assets, such as investments in research and development (R&D), data or software, are a source of increased productivity and growth. Still, not all firms can equally make and receive benefits from these investments.

The tax system can support the development of intangible assets, but design issues must be considered.

To eliminate inevitable market failures, Governments may consider using tax incentives to encourage investment in certain types of intangible capital, especially in cases where the secondary effects are most remarkable, such as providing tax incentives for R&D and innovation.

Taxes and digitalization

In addition to the work being done by the Inclusive Framework on BEPS, digitalization creates challenges and opportunities in other tax areas.

In response to the growing digitalization and growing income needs, an increasing number of countries are implementing OECD standards for the effective collection of VAT on online sales of goods, services and digital products. These standards and recommended solutions for their effective and consistent implementation were included in the BEPS Action 1 report for 2015. These rules and mechanisms are particularly relevant given the ever-growing volume of online sales of offshore suppliers carried out directly to consumers or through the intervention of digital platforms. More than 70 countries, including the vast majority of OECD and G20 countries, have implemented reforms following these standards. These rules and mechanisms have recently been adopted in Canada, Chile, Indonesia, Mexico and Singapore. Many other countries are considering similar reforms.

Politicians also continue to struggle with the consequences of the rapid development of virtual currencies and crypto-assets. Tax systems need to be adjusted to take into account the risks and opportunities associated with crypto assets. It is recommended to formalize the process of regular revision and updating of the guidelines on the taxation of crypto assets and currencies, taking into account their rapid development, as well as an explanation of the reasons underlying the adopted tax regimes to ensure compliance with tax requirements. The OECD is working on creating a reporting system for exchanging information on crypto assets, as noted in the communique of the G20 finance ministers and central bank governors of April 2021. The reporting standard will be based on the Common OECD Reporting Standards and complement them to exchange information on financial accounts automatically. The task is to present it to the G20 in 2022.

Tax policy for the fair society

Tax policy plays a crucial role in solving the problem of income inequality, along with direct transfers.

Tax systems should also provide adequate income support and expand economic opportunities for those at the bottom. Tax measures combined with direct transfers should be used to support household incomes, which in some cases may need to be strengthened after the pandemic.  

Digitalization contributes to the emergence of new forms of work that create new problems for taxation.

Digitalization also increases the mobility of taxpayers at the international level, which may hinder the functioning of personal taxation systems. The mobility of wealthy taxpayers is a long-standing problem, but digitalization increases the risks of tax-related migration. Digitalization has contributed to the emergence of mobile forms, including remote work.

The risks of increased mobility can have profound implications for both tax revenue and equity, given that the tax burden may end up being heavier on less mobile and less affluent people. Thus, it is necessary to carry out work on assessing these risks and begin identifying policy options that can help ensure the adaptation of tax systems to a world in which people are becoming more mobile.

Taxation to ensure environmental sustainability

Limiting the adverse effects of major environmental problems requires profound structural changes. Addressing climate change is a policy priority. Curbing climate change involves reducing greenhouse gas (GHG) emissions to zero by about the middle of the century. To achieve this goal,  carbon dioxide emissions (CO2) and other greenhouse gases should be reduced by a quarter or half compared to 2019 levels by 2030

The IMF estimates that measures equivalent to a carbon price increased by about $75 per tonne of CO2 or more by 2030 in most G20 countries are required to achieve emission reduction targets in nationally determined contributions. .

Existing measures to reduce the impact of carbon pricing and competitiveness (for example, the distribution of free quotas) become less effective with deeper decarbonization.

There is a need to improve the measurement of various mitigation policy tools and approaches. At the G20 High-level Tax Symposium held in Venice on July 9, 2020, ministers noted the relative lack of comparable data on the rigor of policies to reduce greenhouse gas emissions in countries where they take the form of hidden carbon prices.

The G20 has every opportunity to ensure the coherence of mitigation policies. The development and exchange of metrics and indicators of policy approaches is a prerequisite for creating standard processes at the international level. Assessing the relative merits of various responses to negative international spillovers - from "carbon boundary adjustment mechanisms" to "minimum carbon price agreements" and broader "climate clubs" - will help strengthen cooperation to achieve common climate goals.

Tax policy challenges faced by developing countries

There are significant opportunities to improve the functioning and development of VAT systems in developing countries. In particular, reforms aimed at improving the efficiency and the possibility of increasing the income of VAT systems by reducing a significant number of VAT exemptions and reducing the rates that exist in many developing countries.

The main problems related to VAT are associated with the strong growth of online sales of services and digital products to private consumers (such as "apps", streaming music and movies, games, car rides, etc.). And also, with the growth of online sales of imported goods with low cost, often from foreign sellers, from whom existing rules do not charge VAT.

To support developing countries wishing to implement OECD standards to address VAT issues in digital commerce, the OECD, together with the World Bank Group and other partne.organizations, is developing digital VAT tools that provide detailed instructions for implementing a comprehensive VAT strategy at e-commerce.

This includes:

1) the abolition of wasteful subsidies for fossil fuels

2) increasing environmental taxes and carbon prices

through carbon taxes or emissions trading systems.

These measures will need to be accompanied by policies that ensure the availability of energy.

Summary and conclusions. Solving the problems will require a wide range of reforms in taxes, expenditures, governance to finance the necessary investments and subsidies and stimulate changes in behaviour by influencing prices and effective regulation. Since the problems are multifaceted, reforms should also be multifaceted.

Countries will need to mobilize a wide range of policy levers, including a revised fiscal framework, budget rules, revised spending priorities, and tax reforms. A key element in ensuring broad acceptance of new fiscal strategies will be a visible improvement in the efficiency and fairness of the tax and expenditure systems.

Read the original version of the review on the OECD website at the link