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Wołowiec, Tomasz; Skica, Tomasz; Gercheva, Galya
Article
Income taxes, public fiscal policy and economic
growth
e-Finanse: Financial Internet Quarterly
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University of Information Technology and Management, Rzeszów
Suggested Citation: Wołowiec, Tomasz; Skica, Tomasz; Gercheva, Galya (2014) : Income
taxes, public fiscal policy and economic growth, e-Finanse: Financial Internet Quarterly, ISSN
1734-039X, University of Information Technology and Management, Rzeszów, Vol. 10, Iss. 3,
pp. 52-64,
http://dx.doi.org/10.14636/1734-039X_10_3_001
This Version is available at:

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Tomasz Wołowiec, Tomasz Skica, Galya Gercheva, INCOME TAXES, PUBLIC FISCAL POLICY AND ECONOMIC GROWTH,
Financial Internet Quarterly „e-Finanse” 2014, vol. 10/nr 3, p. 52-64 10.14636/1734-039X_10_3_001
INCOME TAXES, PUBLIC FISCAL POLICY

AND ECONOMIC GROWTH
Tomasz Wołowiec* , Tomasz Skica** , Galya Gercheva***
1 2 3
Abstract The main goal of this article is to find the relationship between public fiscal policy and economic
growth. The article consist of a few parts. The first is an introduction, which creates the background for
the analysis in the following sections. It shows the main point of view on public fiscal policy especially
in the case of personal income tax and creates a framework for the analysis of the relationship between
taxation and economic growth. The second part focuses on the relations between central government
decisions on taxation and its influence on savings, investments and economic growth. In this part
we will find selected analyses of the impact of taxes on economic growth based on the examples of
OECD countries. Finally, the last part of the work is a study on fiscal level and tax system structures and
economic growth. In this part the authors checks two points of view on taxation. The first is that a low
level tax burden is conducive to economic growth, and the second emphasizes negative consequences
of decreasing budget tax revenues. The article shows both theoretical and empirical points of view on
taxation and influence of government taxation decisions on the economy.
JEL Classification: H21, H24, H30, E62, F43

Keywords: personal income tax, corporate income tax, budgetary system, fiscal policy, economic growth
Received: 28.04.2014 Accepted: 24.10.2014
Introduction
A simple consequence of the fiscal function of income economic goals achieved through income taxes
taxes is the direct influence on allocation of resources may encounter social barriers, expressed in social
in an economy, as when the tax is paid, there is unrest accompanying, for example, an increasing
a definite flow of income between the taxpayer and tax burden or changes in some elements of income
the state. The fiscal function of income taxes is always tax construction. In market economy conditions the
related to the allocation of resources, as it decreases the reaction of entities on imposed taxes (or a decreasing/
incomes of households and enterprises, which limits increasing tax burden) is of vital importance. Each
their possibility of investing, consuming and saving. reaction depends on the strength and direction of the
The allocation effects of income taxes can be various tax’s influence on changes to demand and supply of
and depend on such factors as: tax rates, capacity of a particular production factor in the market, as well
tax scales, subject and base of taxation, scope and as on the length of time in which the tax’s influence
scale of tax reliefs and exemptions, distribution of on the market will become visible and on changes
the tax burden and the way and mode of collecting to structures of particular markets (Musgrave &
taxes. Income tax is also a social category, and due Musgrave, 1984, p. 268). The analysis of income tax
to the directness and individuality of taxation, some influence on allocation of resources requires analysis
* Ph. D., Tomasz Wołowiec, University of Economics and Innovation in Lublin, ul. Projektowa 4, 20-209 Lublin, Vice Mayor of the
Krynica-Zdrój Commune, wolowiectomek@gmail.com.
** Ph. D., Tomasz Skica, Chair of Finance, University of Information Technology and Management (UITM) in Rzeszow, Director of
Research and Science at the Institute for Financial Research and Analysis (IFRA), University of Information Technology and Management,
ul. Sucharskiego 2, 35-225 Rzeszów, tskica@wsiz.rzeszow.pl.
*** Prof. Dr. Sc., Galya Gercheva, Varna Free University, Bulgaria, Varna Free University „Chernorizets Hrabar” Located at Chayka Resort,
Varna, Bulgaria, 9007, rector@vfu.bg.
52 www.e-finanse.com
University of Information Technology and Management Sucharskiego 2, 35-225 Rzeszów
of two issues: who is the taxpayer and who is the payer more beneficial for affluent taxpayers, as in their
of the tax and what is the subject of taxation (Owsiak, case, a relatively larger part of their income is taxed.
1997, p. 170). Taxation of individuals and economic Increasing the tax-free amount will give the same
activity is associated with the following choice: absolute amount of benefit to all taxpayers who are
1) tax may be imposed on households and companies, above the new tax threshold. Such action will bring
2) the subject of taxation may be production factors and
relatively smaller benefits to richer taxpayers. In each
goods and services, case people below the lower tax threshold will not get
any benefits, as they do not pay income tax, so the
3) tax may be imposed on the seller, the buyer or the
purchaser of production factors, goods or services, poorest groups of income taxpayers will not benefit
from its decrease. In the case of indirect taxes, which
4) the tax may burden the taxpayer’s income or expenses,
are strongly digressive, poor taxpayers will benefit
5) the subject of taxation may be: revenue, income, assets, from them more, so a better redistribution effect can
or consumption (Kaleta, 1985, p. 110-121). be achieved by lowering taxes on those goods and
Each of these solutions exerts specific influence on services which are most frequently consumed by
allocation of resources in an economy, due to the lower income groups of society.
various reactions of production factors to taxation. Each action of the state in economic policy leads to
Through income taxes we achieve a correction redistribution of income or wealth. The basic tool for
of taxpayers’ incomes. Redistribution of national leveling off incomes is budget policy. The influence
product is conducted between taxpayers and public of budget policy depends mostly on the type and
legal entities. Redistribution of income also affects structure of budget incomes and expenditures. For
the level of social and economic life, by protection example, from the point of view of redistribution,
of a minimum income level, taking into account more important than the size of taxes (though this
family, social and other aspects in taxation. Specialist is important, as assuming ceteris paribus it influences
literature also offers an approach in which the scope employment levels and consequently many aspects
of the redistribution function coincides with the of income division) is their type and structure. In
scope of the fiscal function (Gail, 1992, p. 13-24). the case of types of taxation forms, direct taxes
This thesis is related to the assumption that the influence income and wealth division differently
redistribution function of taxes is unilateral, and than indirect taxes. As for the structure, it is vital
consists in taking the means from the budget. The to know the due tax and/or paid tax for each range
actual redistribution takes place only when these of the tax scale. Using the common criterion of the
budget means are allocated for appropriate goals. This course of the function of the average and extreme
is a controversial approach which is hard to accept. tax or tax flexibility in relation to the taxation base,
Taking into account the whole spectrum of tools, we can distinguish proportional (flat), progressive
such as tax reliefs, a system of progressive taxation and regressive taxes1. The tax is flat when along the
that can be used in taxation policy, we can construct growth of the taxation base, the rate of average tax
taxes so that, if needed, they are low for some and extreme tax are equal (T1 = t1 x Y, where t1 is the
taxpayers and high for others. In this way the state extreme and average tax rate, and Y is the taxation
may achieve its fiscal policy goals or, more broadly, base) or when tax flexibility against the taxation base
economic policy goals. The problem here may be ε (t1, Y) equals zero. Taxes are progressive when along
the answer to the question of whether income taxes the growth of the taxation base the extreme tax rate is
perform well the function of redistributing income higher than the average tax rate or when the flexibility
among various income groups of taxpayers and what of the average tax against the taxation base ε (t1, Y)
is the cost of this tax function. Taxation lowers net is above zero. Progressive tax may assume three basic
income, so it can reduce the income level of affluent forms (See: Figure 1):
groups of taxpayers. Income taxes alone, even the 1) with tax-free amount T2 = - K + t2 x Y, where K is the
most progressive ones, will not increase the incomes tax-free amount for all entities obtaining income Y >
of poor or average income groups. A similar problem
appears with tax reliefs as tools of redistributing 1 Average tax rate is the quotient of the total value of tax revenues
income. If we lower the income tax, the net income and the taxation base. Extreme (marginal) tax rate is the quotient
of each taxpayer will increase, but this effect will be of increase in the value of tax revenues and increase in value of the
taxation base.
www.e-finanse.com 53
Y0 = K / t2, and t2 is the extreme higher than average income brackets. Assuming that we have three income
tax rate which equals T2 / Y = - K / Y + t2., brackets from 0 to Y0, from Y0 to Y1 and from Y1
to Y2, for income equaling = Y2, the size of the tax
2) with continuous progressiveness, when the extreme tax
burden will reach: T4 = t0 x Y0 + t1 x (Y1-Y0) + t2 x
rate grows along with the taxation base continuously:
(Y2-Y1), whereas t2 > t1 >t0. If Y1 < Y2, to T4 = t0 x
T3 = t2 x Y + t3 x Y2,
Y0 + t1 (Y1 – Y0) + t2 (Y – Y1), analogically for Y ≤
3) with tax thresholds, when the extreme tax rate grows Y1.
in a non-continuous way, changeable in various
Figure 1: Budget incomes from flat tax T1 (a) and progressive tax
with tax-free amount T2 average tax rates (b)
Source: own elaboration.
Taxes are regressive when together with growth of Public fiscal policy
the taxation base, the size of paid taxes grows more and economic growth
slowly than income or if average tax flexibility against Quality of public finances in this context refers to the
the taxation base ε (t1, Y) is below zero. Regression structure of taxation and public spending as well as
may be direct or indirect. Indirect regression takes mechanisms to maintain a high level of efficiency in
place when the fall in average tax rate is accompanied public spending, such as effective expenditure rules.
by a fixed level of extreme tax. In the case of direct The purpose of this chapter is to shed light on the
regression – a fall in average tax goes along with a fall possible best ways to redirect public expenditure
in extreme tax. towards “productive” items and to ensure that tax
Tax progressiveness can be expressed more generally structures strengthen economic growth. A variety of
with reference to each type of tax. When T is the studies have addressed the issue of the effect of fiscal
value of tax paid by a particular household and Y policy on economic growth, mostly using an aggregate
the value of the taxation base for this household, approach, looking at the impact of total government
then we can determine whether a given tax (or the revenue or expenditure, as a percent of GDP, on
whole tax system) is progressive, flat o regressive, growth (See: Skica, Pomianek, Pater & Tarnawska,
if T/Y respectively: increases, stays the same (is 2009; Skica, 2011). These studies often fail to identify
proportional) or decreases with the growth of Y. channels through which fiscal policy has an effect on
Redistribution through budget policy may also growth, which is the central question. Much less is
be conducted through money transfers (remitting known about whether and how the composition of
financial means) and non-monetary means (providing revenue or expenditure affects a country’s growth
goods and services or donations for particular goods rate.
and services by the state).
Figure 1: Budget incomes from flat tax T1 (a) and progressive tax
with tax-free amount T2 average tax rates (b)
Theoretical aggregation Functional classifications
Part 1. Taxation
Taxation on income and profit

Social security contributions
Distortionary taxation
Taxation on payroll and manpower
Taxation on property
Non-distortionary taxation Taxation on domestic goods and services
Taxation on international trade
Other revenues Non-tax revenues
Other tax revenues
Part 2. Expenditure
General public services expenditure
Defense expenditure*
Educational expenditure
Productive expenditures
Health expenditure
Housing expenditure
Transport and communication expenditure
Social security and welfare expenditure
Unproductive expenditures Expenditure on recreation
Expenditure on economic services
Other expenditures Other expenditure (unclassified)
*R.J. Barro finds that current expenditures less education and defense expenditure is associated with lower per-
capita growth (Barro, 1990; Barro, 1991).
Source: Kneller, Bleaney and Gemmell, 1999, p. 171-190.
In the case of taxation a number of authors have growth was 7.3% in the low-tax group and 1.1% in
studied how the total tax revenue in relation to the high-tax group. The average tax/GDP ratio in
GDP, i.e., the average tax rate, affects growth. An the low-tax group increased from 13.3% in 1970 to
empirical study conducted by Marsden, based on 15.2% in 1979, while it rose from 21% to 23.9% in the
a cross-sectional analysis of 20 countries, is a good high-tax group during the same period. Moreover,
example of this kind of analysis (an aggregated fiscal incentives provided by low-tax countries
approach) (Marsden, 1990, p. 23-34). In this study shifted resources from less to more productive
the countries were split into pairs, with each pair sectors, thus raising the overall efficiency of resource
having similar per capita income, but different utilization. Many other studies find a significant
levels of taxation. The selected countries were negative effect of tax revenue on GDP growth
compared on the basis of lower and higher levels of (compare: Engen & Skinner, 1996; Cashin, 1995,
taxation and their influence on growth rates over p. 237-269; Fölster & Henrekson, 1997). Yet, the
the period 1970-1979. In all cases, the countries size of the effect differs considerably. Other studies
that imposed a lower effective average tax burden cannot find a relationship, be it positive or negative.
on their populations achieved substantially higher Again, no study so far has shown a positive
rates of GDP growth than did their more highly relationship between high taxation and growth.
taxed counterparts. The average annual rate of GDP
Table 2: Selected analyses of the impact of taxes on economic growth on the example of OECD countries
Impact of taxation on
Study Research area Extent of impact
growth
1pp of GDP increase in

23 OECD countries 1971- taxes/GDP ratio lowers
Cashin (1995) negative
1988 production per employee
by 2%
2.5pp increase in taxes/GDP
USA, sample from OECD
Engen & Skinner (1996) negative ratio reduces economic
countries
growth by 0.2-0.3%
10pp increase in taxes/GDP
Leibfritz, Thornton & Bib-
OECD countries 1965-1995 negative ratio lowers GDP growth by
bee (1997)
0.5-1%
1% GDP increase of perso-
nal income tax lowers GDP
OECD (1997) Model Quest negative
growth by 2.4% compared
to base scenario
1% of GDP increase of
Bleaney, Gemmell & Kneller 17 OECD countries 1970- distorting* tax revenues/
negative
(1999) 1994. GDP lowers GDP growth
per capita by 0.4pp
Sample of the most affluent 10pp increase of taxes/
Fölster & Henrekson (2001) countries of OECD and negative GDP lowers GDP growth by
outside OECD 1970-1995 about 1%.
1pp increase in taxes/GDP
Bassanini & Scarpetta 21 OECD countries 1971-
negative lowers GDP growth/per
(2001) 1998
capita by about 0.3-0.6%.
1pp GDP increase of in
PricewaterhouseCoopers 18 OECD countries 1970-
negative direct taxation/GDP lowers
(2003) 1999
GDP growth by 0.2-0.4%
*distorting tax revenue = revenue from taxes on income and profit, social security contribution, tax on payroll,
tax on property.
Source: Leach, 2003.
Clearly, in practice, almost all taxes are distortionary The influence of income taxes
to some degree and the key issue in the search for on demand and supply
a long-run growth effect of various taxes is whether In the macro-economic perspective, income taxes
these distortions can be expected to be substantial influence the shaping of demand, supply, and
or minor with respect to the main determinants of equilibrium in the market of a specific good as
growth, such as investments and technical progress. well as decisions made by producers, consumers
It is shown that the effects of taxation on growth and investors. Imposing or increasing tax on
depend crucially on the elasticity of the labor supply, a particular good will lead to decline of its sale
the specification of the leisure activity as well as the revenue, consequent decline of demand for it and
structure of human capital accumulation, and its decline in its net price. Increased gross price is
tax treatment. Stokey N., and Rebelo S. show that covered partly by the seller and partly by the buyer.
large growth effects of fiscal policy occur when The proportions of their participation in covering
depreciation rates are implausibly large and/or when the increased price depend on such economic
the uncompensated labor elasticity is implausibly conditions as demand and supply and the possibility
high (Stokey & Rebelo, 1995, p. 519-550). the seller (producer) has to affect the level and
structure of their own costs. In strict rigidity of
demand, the whole burden of imposing (increasing) Undoubtedly, high (progressive) income taxation
income tax will be covered by the buyer. If supply is limits private investment by reducing that part of
rigid, imposing or increasing taxation will not cause income that could be allocated to investment, leaving
changes to the gross price of a particular product, taxpayers with the means that are sufficient only for
but its net price will change by the amount of consumption. Some researchers (Young, 1994, p.
imposed (increased) tax. The entire tax burden will 112; Young, 1990, p. 255) are of a different opinion,
be covered then by the seller. If demand for a given claiming that progressive income tax does not lower
product is infinitely flexible, the consequence of the attractiveness of risked investments compared
imposing or increasing the tax would be seen in with risk-free investments for two reasons. Firstly,
limitation of this supply at increased gross prices taxation reduces the general level of a taxpayer’s
until the balance is achieved as determined by the income, so their attitude to risk may change. This
buyers’ willingness to pay a higher price. So the less effect is observed regardless of the form and method
flexible the demand and supply, the smaller income of income taxation and depends only on the size
tax’s influence on a particular type of economic of the tax, that is the scale of decreasing income
activity, as imposing (increasing) taxation does not after taxation. Whether income tax decreases or
provoke any significant changes to allocation of increases risk-taking depends on the shape of
resources. The higher the flexibility, the greater the its usefulness function. Secondly, as claimed by
influence on allocation of resources (Owsiak, 2000, Young – high effective income taxation decreases
p. 172-175). the scope of expected income after taxation, which
Income tax affects the price of a taxed product encourages entities to take risks3. Obviously, Young’s
and price growth influences the market situation. assumptions may seem slightly controversial, as
Increasing tax rates may lead to a situation in high effective rates of income taxation, through
which the taxpayer’s gross taxable income remains reduction of a taxpayer’s income, do not have to
unchanged – then their net income after taxation encourage them to increase risk. Moreover, Young
decreases or the taxpayer manages to increase gross adopts a simplifying assumption that taxpayers
income, and in this way their net income after do not differ in their degree of aversion to risk,
taxation does not change. In the first case increased thanks to which he states that a non-negative tax
taxation may translate into either declining scale is indifferent to risk only when it compensates
direct consumption or declining savings. Lower absolute or proportional sacrifice 4. If U(x) presents
consumption leads to decreased revenues from usefulness for income x at no taxation, and t = f(x)
direct taxation unless the growth of income tax rates is a tax scale, then V(x) = U(x – t) is the usefulness
is accompanied by growth of indirect tax rates. This,
however, may cause further decline in consumption against capital costs equals 0.25-1.0. In the USA decline of tax
or decline in savings and capital supply. revenues of 1 billion dollars was accompanied by increase of
expenditure on R&D by 2 billion dollars. In relevant literature
we can notice suggestions that resignation from a capital tax
Influence of income taxes on savings and and introduction of a consumption tax leads to the situation in
investment which investment decisions are not disturbed by tax policy. At the
inflation rate of 3%, financing investment half with debt and half
In a market economy allocation decisions are more
with new shares, and switching from a capital tax to a consumption
or less related to money savings of entities. The tax, we observe investment growth of 10% while the increase of
inclination of the entities to save depends on both social wealth stemming from lowering capital taxes equals 25
interest rates on bank deposits and on inflation, cents per dollar, for one dollar of decrease. Low inflation is the
best incentive for investment, as it lowers the costs of capital (high
as well as on the taxation rate of capital incomes inflation translates into a growing interest rate, decreases profits
(money savings). Also the inclination of economic at stock exchanges and discourages from investing in companies
entities to invest is affected by incomes from which raise their capital). A combination of anti-inflation
monetary policy and switching from income tax to consumption
invested capital. A high burden placed on capital tax significantly stimulates investment. Research suggests the high
incomes may limit their extreme productivity, flexibility of a capital resource against its cost in the long term (see
causing investments to be allocated in preferentially more in: Hall, 1993; Judd, 1987, p. 675 – 709).
3 H. P. Young claims that both these effects cooperate with each
taxed sectors, but of lower productivity, which leads
other in a complex way, and their net influence on the taxpayer’s
to distortion of investment decisions2. behavior depends on the progressiveness and size of income
taxation and aversion to risk (compare: Young, 1994, p. 112).
2 Some researchers imply that there is a statistically significant 4 Taxpayers differ in degree of risk aversion, so there is no tax
influence of income taxes on investment. Investment flexibility function that could be neutral to each taxpayer.
of the taxpayer to income after taxation. A tax scale capital incomes (interests on bank deposits, bonds,
is neutral to risk if the taxpayer makes the same units of investment funds, dividends from company
choices with or without taxation. As the usefulness shares) decreases the effective return rate, thus
of von Neumann-Morgenstern is determined for lowering the benefits savings bring. In consequence,
positive linear transformation, it is identical with the we could expect a decline in the savings level
statement that V(x) = U(x – t) = AU(x) – B for A > 0. (substitution effect), but we also experience an
If A = 1, then U(x) – U(x – t) = B, which means that t income effect – a decline of effective return on the
compensates absolute sacrifice. In a situation where savings rate which translates into lowering the
A ≠ 1, and b = B(1 – A), then [U(x – t) + b] / [U(x) + households’ wealth level. This may lead to limiting of
b] = A. As assumed t ≥ 0, and U is increasing, so A < the current and the future consumption. Limitation
1. Therefore tax compensates the sacrifice rate at the of current consumption may lead to an increasing
rate of 1 – A (compare: Young, 1994, p. 112; Young, savings level.
1990, p. 255). It should be observed that the above The effect of real net rate decline as a result of taxing
argument has some weaknesses. First of all, the incomes on savings is not clearly determined due to
usefulness function cannot be assessed individually substitution and income effects. Economic research
for each taxpayer, therefore we should not “average” shows that in the long term the substitution effect
individual decisions of taxpayers. Moreover, the is stronger than the income effect and decline in
degree of aversion to risk varies, which significantly net return rate coincides with decline in the savings
influences the division of social roles and social supply 5.
division of work as well as consumption and Statistical analysis conducted on a group of 20 OECD
investment decisions made by taxpayers. countries for the years 1970 – 1994 confirms the
negative relation of households savings rate not only
Substitution and income effects – real return to the size of the budget deficit, unemployment rate,
on savings rate after tax versus savings supply current account deficit, demographic structure but
In classic economic theory the size of household also to the size of personal income tax. Econometric
savings is influenced by the rate of return on savings, equations have the following form (see: Formula 1).
which constitute “unconsumed” income. Savings
are a result of choosing a particular structure of 5 The results of savings flexibility estimation conducted on
the basis of data from OECD countries do not confirm a strong
consumption in time by households by comparing
correlation between real interest rate and savings supply, which
the subjective value of current consumption against undoubtedly may be affected by liberalization of financial markets,
future consumption (discount rate) to market and the scale of international capital flow. The panel survey in 21
interest rate determining the degree of increasing OECD countries showed that taxation of capital incomes causes a
slight but statistically significant drop in savings (elimination of
future consumption as a result of resignation from capital income tax, whose average rate is 40% leads to increase of
current consumption (interest rate). Taxation of savings by 0.5% GDP). (compare: Tanzi & Zee, 1998).
Formula 1: Relations between households savings and the size of the budget deficit,
unemployment rate, current account deficit, demographic structure and the size of personal income tax
x = 1,13 r – 0,44 a65 – 0,17 db + 0,74 ob and;

x = -0,32 PIT – 0,19 ur
Where:
x – household savings rate in %;
r – GDP growth rate;
a65 – share of people aged 64+ in total population number;
db – share of budget deficit in GDP;
ob – share of surplus of current balance in trading with other countries in GDP;
ur – unemployment rate.
All coefficients of variables are statistically significant. research by M. Feldstein, who proved that an extreme
The negative influence of high personal income taxes tendency for consumption from retained company
on the household savings rate was also confirmed in incomes equals around 2/3 of an extreme tendency
for consumption from personal incomes. This affluent households in the maturity stage of their life
means that companies generate higher savings than cycle.
households 6. Progressive taxation of incomes mostly burdens
incomes of households with extreme inclination
Disposable income versus size of savings for saving. These households transfer part of their
If in the long term decreased taxation of incomes income to households from the initial and final stage
from work and savings leads an increased budget of the life cycle (supporting children and parents
deficit, then households (taxpayers) expect that with transfers). This provokes a conflict between
income taxes will grow in the future. Taxpayers will an egalitarian tax policy and solutions aimed at
save part of additional disposable income obtained stimulating households’ savings level. An important
as a result of decreased personal income, aiming at role in the analysis of this process is the warranty
leveling distribution of consumption expenses in the state gives that social and retirement allowances
time. Assuming altruism between generations we will will be paid (financed by quasi income taxes –
achieve the same effect regardless of whether income contributions which place a burden on labor), as
taxes will grow during the lifespan of a household the existence of such a warranty system eliminates
or whether tax growth will affect their descendants. uncertainty connected with unfavorable incidents
In this case we have substitution between savings of which may happen to households and somehow
public and private sectors, but the surveys of EU and limits the inclination (need) for saving. In a situation
American economies did not confirm full substitution where social transfers come from current revenues
of public savings with private savings 7. of the public sector, we may experience a decline in
aggregated savings and weakening of possibilities for
Income taxation versus the social security financing investment 8. It seems vital then to limit
system and savings supply financing of retirement allowances from current
Progressive taxation of incomes may lead to decline public revenues. Research conducted by Feldstein
in savings. The hypothesis of life cycle assumes that M.S., and Samwick A., indicates that the change of
every household aims at balancing their expenditure the social security system for the system financed by
within its life span, so in the beginning they increase funds may in the long run increase US GDP by 5%
their debt in order to increase current consumption, (Feldstein & Samwick, 1996). Taking into account
expecting higher incomes in future that would allow differences in extreme inclinations to saving between
them to pay off the past debt. Households also expect households with varied incomes, we can notice that
their incomes to decline at the end of their life, which limited access to capital (loans) is experienced by
accounts for the fact that they save part of their income households with low income, which means that
in order to consume it after they retire. We can notice they have to finance the purchase of durable goods
that the lowest inclination to savings is demonstrated from their own means. Limitations in access to
by households who are not professionally active (the loans combined with a high level of income taxation
retired), slightly higher – by households in the initial limit consumption expenses of households and
stage of the life cycle, and the highest – the most may simultaneously increase savings at a particular
distribution of incomes.
6 In open economy conditions, a relatively low and declining
inclination to save does not have to be a factor that limits the Taxation and substitution between
size of investment and the pace of economic growth, due to the household savings and company savings
progressing process of import and export of capital between
different social and economic systems. Therefore personal income If households treat retained profits of owned
tax (in conditions of significant openness of economies and free companies as their own savings, then the level
flow of capital) does not have to stimulate the inclination to of corporate income taxation may significantly
save and invest (unless the lawmakers use various tax reliefs and
exemptions). It may be not the personal income taxation but the
behavioral hypothesis which emphasizes the limited rationality 8 In most OECD countries revenue from social insurance
and self-control of loan-takers that partially explains the declining contributions is higher than revenue from personal income tax in
saving trend in most OECD countries. the structure of budget tax revenues (at both regional and central
7 Correlation ratio evolves below one, some deviations concern levels). A visible trend is quick growth of contribution share in the
only special cases (quick budget deficit growth, substitution structure of budget tax revenues and hiding the increased personal
between public and private savings in retirement and the social income tax burden by increasing the retirement contribution
security sector). burden (the so-called “tax wedge”).
influence household savings. Households may save level of tax burden is conducive to economic growth,
more when companies retain less profit and save less therefore it is beneficial to lower real tax rates. The
when companies retain more profit. In a situation structure of a tax system is neglected, what really
where extreme inclination for savings of households matters is the general level of the tax rate (the share
which own major shares in company profits is above of taxes in GDP) and rates of the fiscal burden (the
the average population’s inclination, the growth of share of all fiscal burdens in GDP). Reduction of
the tax burden on profits (incomes) of legal persons, budget revenues will be set off after some time with
combined with lowered personal income tax may higher tax revenues resulting from an economic
lead to decline in the aggregate savings of the private boom. If such a set off does not fully succeed, we
sector (Nojszewska & Rojek, 2003, p. 153). Summing will witness another effect of lowered taxes, namely
up, we can state that a growing taxation of incomes decreasing participation of the state budget in GDP
from savings may lead to a decline of aggregate redistribution. The liberal school representatives
savings stimulating investment objectives, mainly claim that it is a positive phenomenon, as expenses of
through lowering disposable income, lowering return private entities are more effective from the economic
on the savings rate and transfer of income between growth perspective than public expenses. The second
households with varied inclinations for saving. group questions the direct influence of low taxes
on economic growth, emphasizing the negative
Capital income tax wedge consequences of decreasing budget tax revenues.
versus cost of capital Poor financing of some branches of the economy
A vital factor affecting the size of investment is the (infrastructure, administration, education, etc.),
cost of capital which depends on the interest rate (see: hampers the economic growth rate. Advocates of the
Gordon & Dietz, 2006; Auerbach, 2005; Auerbach & above view also point out that the possibly positive
Hassett, 2006; Auerbach, 2006, p. 399-420). Taxation effects of lowering taxes appear only after a few years,
of incomes from investment or savings increases while the budget experiences instant losses.
the difference between the return on the savings Public discussions concerning tax system reforms are
rate before personal income tax and the return on dominated by the view that lowering taxes is the only
the investment rate after taxation. It is a specific tax panacea for stimulating economic growth (see: Skica,
wedge between savings supply and capital demand Wołowiec & Reśko, 2012). But is this really so? To be
which generates decline of net return on the savings able to answer this question we need to examine how
rate and increase of gross return on the investment the level of fiscal burden and structure of budget tax
rate and, as a result, decline of investment outlay 9. revenues are correlated with the GDP growth rate.
Analyzing the influence of investment income we A relationship that is particularly examined is the
should concentrate on effective tax rates, as very often correlation between the level of fiscal burden in
lowering nominal (statutory) rates does not have to personal income tax and the economic growth rate.
stimulate investment growth if the accompanying Considerably less attention is paid in various analyses
changes to tax law (elimination of reliefs) lead to to the influence of the structure of budget tax revenues
growth of the real tax burden. on economic growth.
Below we will present the relationships between
Fiscal level and tax system the fiscalism level10 (the relationship between tax
structure vs. economic growth revenues from PIT and social insurance contributions
As far as the influence of fiscal level and tax system to average annual GDP growth rate, calculated in line
structure on economic growth is concerned, we often with purchasing power parity per inhabitant) and the
encounter opposing views. They can be roughly
divided into two groups. The first believes that a low
10 By state fiscalism we understand redistribution of gross value

9 Complicating tax law by various tax reliefs and exemptions, added (together with debt). In analyses of the level of fiscalism
principles of depreciation write-offs, evaluation of stocks, three indicators can be distinguished: state expenditure rate –
deduction of exchange rate profits and losses, leads to the being a relationship of expenditure to GDP, narrower measures are
disappearance of a simple relationship between gross return on the offered by: tax rate, that is the relationship between taxes and GDP,
investment rate and net return on the savings rate, determined by and fiscal burden rate, being a relationship between taxes and other
statutory tax rates. non-tax burdens related to labor costs and GDP.
structure of the tax system, and the economic growth characterized by a negative relationship between
rate for 27 EU countries for 1991-2012 11. changes to fiscalism and GDP growth rate presented
Using the notion of fiscalism we should also include annually. We could form a thesis that only in the long
all kinds of social insurance contributions and their term can we notice a negative influence of the level
derivatives in our research, as they also burden of fiscalism on economic growth dynamics and rate.
personal incomes and determine labor costs for Adopting an assumption that income tax lowers
employers12. Examining income tax in isolation from incentives to work by reducing the remuneration
the obligatory burden related to social insurance may level, decreasing the size of income tax will increase
lead to the drawing of wrong conclusions. Social incentives to work and to increase one’s income.
security systems are financed from various sources. This is a partly justified view as taxpayers, as
These can be both premiums paid by taxpayers and a result of decreasing net income by increasing
direct financing from the state budget (premiums are taxes, may be motivated to work in order to satisfy
then included in general taxes). their consumption needs. Moreover, increasing net
Using Pearson’s correlation coefficient we can analyze income through lowering taxes may lead to quicker
the power and direction of relationships between the satisfaction of taxpayers’ consumption needs and
level of fiscalism and average annual GDP growth a lower willingness to take up additional activities in
rate. The coefficient sign informs us of the correlation order to increase one’s income. Therefore, the effect
direction, while its absolute value – of the relationship of lowering the taxation level may be a slower GDP
power13. The obtained value of linear correlation growth rate, as reducing tax rate levels improves
coefficient rxy = -0.56 denotes the existence of taxpayers’ material situation and, as a result,
a statistically negative relationship between two decreases labor supply. We should also remember
variables. The determination coefficient obtained on that in a situation of ‘saturation’ of the tax system with
the basis of Pearson’s correlation coefficient allows us various investment reliefs, lowering taxes weakens
to state that the average annual economic growth rate their motivational effects.
in 27 examined countries in 31% of cases is explained The research shows that in a short period of time it
with an average level of fiscalism. The analysis of the is difficult to demonstrate the relationship between
above data allows us to state that an increase of the reduction of tax rates and GDP growth rate.
level of fiscalism by 1% leads to a decreased economic Negative correlation means that the higher the level
growth rate per capita by 0.14%. of extreme tax rates, the lower GDP growth. The
On the basis of the above results of the survey we obtained correlation coefficients are statistically
can state that countries with a high level of fiscalism insignificant, so small that there is no reason to
generate a lower economic growth rate. In the reject the hypothesis concerning the existence of
ten-year period of research not all countries were a relationship between the level of extreme rates in
a short period of time. These results do not confirm
11 The notion of tax and quasi-tax incomes (social insurance the theoretical postulates of the economics of supply
contributions and their derivatives) correspond to the term of school. Its advocates argue that reduction of extreme
tax revenue used in OECD terminology (See: Revenue Statistics tax rates in income tax leads to lower labor costs,
of OECD Member Countries 1965 – 2012, (2013), Paris: OECD).
12 R. J. Barro defines summary tax burden in relation to GDP stimulating consumption and production, and, as
as the taxation rate. He lists here PIT, CIT, indirect taxes, property a result, shifting the global supply curve so that the
taxes and social insurance premiums (See: Barro, 1990; Barro, demand and supply equilibrium point determines
1991).
13 Correlation coefficient adopts the values from [-1;1] range.
a higher level of GDP and lower prices. This action
Absolute value of the coefficient indicates the power of correlation is to lead to economic growth and a lowered inflation
between two variables. The most correlated variables are those in rate. These activities may result in an increased trade
which the coefficient value is close to 1 or -1, the least correlated
deficit caused by growing demand for consumption
ones are those with coefficient close to 0 (positive or negative). The
correlation coefficient sign shows the direction in which variables and investment goods and an increased capital
are correlated. If it is positive, we talk of positive correlation surplus due to inflow of foreign capital and decreased
between variables. This means that an increase (decrease) of the outflow of domestic capital abroad.
value of one variable is accompanied by an increase (decrease)
in the value of the other variable. If it is negative (the so-called Apart from the influence of the level of fiscalism
negative correlation of variables), it means that the growth (fall) on economic growth, of vital importance is also
in the value of one variable is accompanied by the fall (growth) of the analysis of the structure of budget tax revenues
the other variable.
(together with quasi-taxes). It will allow us to answer the so-called tax wedge, that is the labor costs (the
the question of how particular types of fiscal revenues difference between the labor cost – the pay costs for
influence the GDP growth dynamics. We analyzed the entrepreneur and net pay – pay income), extremely
three tax groups. The first is composed of income vital for the willingness of entrepreneurs to create new
taxes (PIT, CIT and taxes on capital gains), the second jobs. Moreover, these terms are used interchangeably.
– social insurance contributions and their derivatives, Analyzing the span between the share of particular
while the third – incomes from work (jointly PIT and fiscal contributions in EU countries with their highest
social insurance contributions with their derivatives14. and lowest levels, we can notice that the span of PIT
Isolating the fourth group is justified by the fact that share in total fiscal revenues in the EU countries in
social performance may be financed with general 2012 amounted to roughly 39%, while in the case of
taxes or from premiums outside the budget, in the social insurance contributions – 34%. In the case of
form of a burden classified as social insurance. a joint burden on work income, the span was 21%,
Analyzing the influence of income tax share in fiscal therefore it is justified to analyze the total influence
revenues on the GDP growth rate we obtain the of contributions burdening labor costs on economic
Pearson’s linear correlation coefficient at the level of growth.
rxy = 0.12. The obtained value of the coefficient means On the basis of the data below we obtained the
that there is no statistically significant relationship correlation coefficient of rxy = -0.55, which denotes
between income tax share in fiscal revenues and the existence of a statistically significant negative
average annual GDP growth rate. Similar results are relationship between the share of work income
obtained when analyzing the discussed relationship burden in fiscal revenues and GDP growth rate. The
annually in particular years (with an exception of the coefficient of determination calculated on its basis
Netherlands). Examining the power and direction tells us that the average economic growth pace in the
of the correlation between PIT and CIT separately examined years is explained in 29% of the situations
and average annual economic growth rate, we also by the share of work income burden in total fiscal
obtain statistically insignificant relationships. The revenues.
obtained correlation coefficients equal, respectively The obtained results allow us to state that an increase
rxy = 0.05 and rxy = 0.37. Thus the income tax share of average share of pay burden in total fiscal revenues
in the structure of budget fiscal revenues does not of 1% accounts for a decline of GDP per capita by
significantly affect economic growth dynamics (either 0.11%. We can thus state that a high level of burden
in the short run or in the long run). Determining on income from labor negatively affects economic
the power and direction of the relationship between growth. High labor costs lower competitiveness of
social insurance contributions share in total fiscal the national economy and increase the tendency
revenues and average annual GDP growth rate per to escape into the shadow economy and increased
capita, we obtain the correlation coefficient rxy = - unemployment, which in turn hampers the economic
0,44. This result confirms the existence of a negative growth.
relationship between the analyzed variables. The Examining the relationship (for the years 1991-
power of the relationship does not qualify it as 200) between average annual unemployment
statistically significant, therefore the thesis of level (a dependent variable) and average share of
a negative influence of a high level of social insurance contributions constituting a burden on labor costs we
contribution burden on economic growth cannot be will notice a strong relationship, assuming a three-
fully confirmed (see: Wołowiec & Skica, 2013). year delay of unemployment rate reaction. In this
Combining personal income tax and social insurance assumption the correlation coefficient is rxy = 0,96.
premiums into one group we obtain a category An increase of 1% in average share of burden on pay
of incomes placing a burden on work. These in total fiscal revenues of EU countries, assuming
performances are complementary and determine a three-year delay, accounts for an increase of the
average unemployment rate of 1.5%.
Summarizing, we need to remember that each
14 On the basis of tax classification developed by OECD and
EUROSTAT. More on classification in: Revenue Statistics of OECD increase of tax and quasi-tax burden may translate
Member Countries 1965 – 2012, (2013), Paris: OECD; Structures into a slower economic growth rate. The research
of the taxation systems in the European Union 1995-2012, (2013), shows that the most negative influence on economic
Luxembourg: Eurostat.
growth, especially on unemployment level, is exerted price flexibility of demand, etc.), to propose a thesis
by fiscal burden constituting the so-called labor costs. that it would be more beneficial from the point
Interestingly, contrary to popular belief, the research of social and economic prosperity to increase the
did not find any correlation between the level of revenues from indirect taxation in the structure of tax
income tax burden on the economy and economic budget revenues. Lowering the income tax burden
growth. The obtained research results do not allow us requires redressing the balance with increased
(without detailed micro-economic analyses, such as indirect taxes.
level of household affluence, their expense structures,
Conclusions
However, we should bear in mind that this may cause 6) Indirect taxes, placing a burden on consumption
several negative consequences. expenses, most negatively affect the incomes of poor
households (in the case of New Member States such
1) An increase of actual rates of tax on goods and services households generate 80% of global demand), which
may lead to unfavorable allocation of production to violates the principle of equity and equality of taxation.
goods of lower price flexibility of demand. Indirect
taxes use customers’ usefulness preferences in order 7) In a situation where increased indirect taxation mostly
to satisfy budget financial needs, but the structure of concerns domestic rather than imported goods, this
the economy shifts towards goods with low demand weakens the situation of domestic producers.
flexibility (basic goods). This may weaken the economic 8) Increased indirect taxation of basic goods leads to social
growth by shrinking the market for higher demand stratification by accumulating economic inequalities in
goods that stimulate the economy’s competitiveness. domestic product distribution, especially in the case of
2) Price growth caused by increased rates of indirect taxes a high share of household expenditure on basic goods
may lead to inflation processes. If consumption goods (this is typical of NMS, according to Engel’s law).
with low demand flexibility become more expensive, The evaluation of the influence of income taxes on
low flexibility will not cause decline in demand (or it
taxpayers’ behavior and, as a result, on economic
will fall only slightly). Producers will increase their
prices which will provoke the multiplier reaction of growth, requires taking into account the whole
changes to other prices. Households burdened with external environment in which taxes are one of
higher prices of basic goods will limit their demand the major elements, though an element that does
for more sophisticated goods, therefore their prices not function or determine economic growth
and production will decrease. Producers reduce
independently. The environment may both hamper
production and the general price level is determined
by goods with low price flexibility of demand. and stimulate economic growth as well as shape itself
independent of taxpayers’ intentions.
3) High (increasing) rates of indirect taxes, through an
We can differentiate the following elements of the
increased level of prices and inflation effect, lead to
decline in the society’s real incomes, lower demand, environment.
decline in production and, as a result, a slower 1) State of the market (prices and currency exchange
economic growth rate. rates, state and intensity of competition, payment
bottlenecks, economic climate, etc.).
4) Price growth being the result of growing indirect tax
rates, in the long run generates pressure on increasing 2) Social and material infrastructure (banking and
salaries in order not to weaken global demand in an insurance system, education, corruption, state of
economy. This causes increased costs of salaries and administration, system of justice, etc.).
other production factors (providers of these factors, by
3) Fiscal and monetary policy of a state (custom duties,
increasing the required price, compensate their costs
public aid, height of the budget deficit, interest rates,
by transferring the tax burden). Thus we experience the
taxes and tax reliefs, etc.).
indirect burden of indirect taxes placed on enterprises.
4) Regulative and administrative influence of the state
5) Price growth, being the effect of increased burden of
(legal regulations in particular sectors, labor market
indirect taxes, leads to increased supply of money,
regulations, EU sanitary norms, norms shaping
according to the Irving Fischer equation of exchange.
production quality, etc.).
This may account for an imbalance in the monetary
system.
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Wołowiec, Tomasz; Skica, Tomasz; Gercheva, Galya

e-Finanse: Financial Internet Quarterly

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INCOME TAXES, PUBLIC FISCAL POLICY

JEL Classification: H21, H24, H30, E62, F43

Received: 28.04.2014 Accepted: 24.10.2014

Source: own elaboration.

Theoretical aggregation Functional classifications

Taxation on income and profit

1pp of GDP increase in

x = 1,13 r – 0,44 a65 – 0,17 db + 0,74 ob and;

10 By state fiscalism we understand redistribution of gross value

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