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Tax Revenue and the European Debt Crisis

July 12, 2011

Taxes have been one of the main sub-themes of the current European debt crisis:  Greece needs to tighten tax enforcement as tax evasion has helped led to the Greece government’s continuous government deficit; Ireland’s refusal to increase its corporate tax rate has prevented it from receiving a more favorable interest rate on its bailout; etc.  Eurostat has recently released data on tax revenue across the EU, and the data shows an interesting picture.  The graph below shows the total tax revenue collected by an EU member in 2009 (latest year available).  The dark lines represent countries that use the euro while the light blue bars are EU countries outside of the euro.  In addition, the “PIIGS” are outlined in red.

One suggestion for solving the European debt crisis is to create an “European financial ministry” and harmonize tax rates across the EU.  As the chart shows, the tax burden varies widely across the EU, ranging from 48.1% in Denmark to 26.6% in Latvia.  Even within the Eurozone, the gap is 15.3% between high tax Belgium and low tax Ireland.  Secondly, the PIIGS tend to be clustered near the low tax end of the group.  Four of the PIIGS (those that had been seen as being the most at risk of default until recently) are four of the five countries with the lowest tax revenue in the Eurozone.  Only Slovakia has a tax revenue rate similar to these countries, but Slovakia’s tax regime had been very successful by drawing investment from Western Europe.

The fifth PIIGS is Italy, which had managed to appear to be the PIIGS most likely to survive the debt crisis relatively well.  However, in the last week the markets have started to focus on Italy due to a new austerity budget and differences between Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti.  Italy has long had the largest government debt in Europe in absolute size, yet is also has the second highest tax collection rate among the Eurozone at 43.1%.  With this high rate, it is not clear that Italy could really increase taxes to pay for its debt as bond interest rates increase, but instead will have to decease spending in other areas.

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