How Can Tax Reform Boost Economic Growth?

In a modern-day economy, taxation is one of the most powerful tools in control of the government to shape the economic landscape, as well as to effectuate its economic policies. As time went on, developed countries, especially in Europe, began to use this tool ever more extensively, contributing in such a way to the creation of a sprawling and complex fiscal system.

I intend to argue in this short essay that a tax reform that would entail a significant reduction in the complexity of the taxation system would be highly instrumental in boosting economic growth in European countries by creating a favourable environment for both businesses and individuals to remain in their countries, and by reducing the expenditures related to fiscal compliance.

Numerous research studies have been conducted in an effort to understand the relationship between the tax rate and the economic growth of a given country. The results based on the historical data seem to be inconclusive, pointing to a non-existent link between tax rate and economic growth, with the latter being mostly explainable through the lenses of monetary policy, as opposed to fiscal policy (Gale & Samwick, 2014).

Furthermore, a reduction in taxes would not be a recommendable course of action for many developed economies, especially in Europe, as that might lead to an imbalance of the government’s spending, leading to either spending cuts, which may hurt the economy by depriving it of growth-stimulating investments, or to deficit spending, which would lead to an increase in the public debt. Regarding this final scenario, it is important to stress that the total debt-to-GDP ratio of developed countries members of the OECD already exceeds 120% (OECD, 2022), which is already far above the 95% threshold above which it has been found that additional debt-taking by the government causes deleterious effects on economic output (Burriel et alia, 2020).

Therefore, although more in-depth analysis of the conditions of the individual countries may lead to the conclusion that a reduction of the tax rates may be beneficial for economic growth in specific instances, this approach may not be considered a recommendable policy for developed countries in general to apply.

Instead, the focus in developed countries’ ministries of economy should be on simplifying the tax code, making it simpler, more intuitive, and more predictable for individuals and companies to complete their tax statements. A comprehensive reform of the tax system to simplify the overly complex system that is currently in place would significantly reduce the amount of time that is devoted every year to ensuring compliance with tax regulations, and along with it the costs associated with the process.

Furthermore, reputable studies have been conducted that show the possible benefits of the adoption of a tax reform as described above, going as far as to predict a long-run GDP growth of 2.5% while maintaining the revenue generated by the government stable at pre- reform levels (McBride et alia, 2023). The study suggests that such economic growth could be achieved through the reforms by avoiding the double taxation of businesses’ incomes and improving the incentives to work and invest. A similar reform proposal has been proposed by the Istituto Bruno Leoni, a leading Italian think tank which proposed the radical simplification of the complex Italian taxation system to be replaced by a single, flat tax (IBL, 2017).

To conclude, it is of crucial importance for developed countries to proceed with a radical simplification of their tax codes; doing so would simultaneously have the most desirable effects of stimulating economic growth, job generation, while maintaining a stable tax revenue. This is a process from which every single party involved stands to gain: the citizens and the corporations by reducing their expenditures of time, human resources, and money on fiscal compliance; the government by ensuring its ability to perform the functions of which it is tasked without putting an excessive strain on the people it is meant to serve.

Marco Besana