**4. Determinants of fiscal sustainability in welfare state**

In the first equation, where fiscal space as the proxy of fiscal sustainability is a dependent variable, welfare expenditures have a negative impact on the fiscal sustainability of the welfare state at a statistically significant level. Moreover, although the magnitude of the negative impact of welfare spending in the lagged term is somewhat smaller, the increase in welfare spending in the medium term tends to lower fiscal space even further. On the other hand, the results of the second equation with welfare expenditures as a dependent variable demonstrate that welfare expenditures increase as the fiscal space increases at a statistically significant level in the medium-to-long term. This supports the argument that it is essential to secure fiscal space for the continuation of the welfare state in the long term [5].

If we look only at the results of the first equation, it may be argued that public welfare spending must be reduced, because welfare spending lowers the nation's fiscal space. However, considering the political resistance that may be caused by the reduction of welfare expenditures, it is necessary to examine how financial resources can positively influence fiscal sustainability. At first, increase of tax revenue may offset the negative impact of welfare expenditures on the fiscal sustainability of the welfare state as well as positively affect the fiscal sustainability of the welfare state (**Table 5**).

It is noted that the perception of tax burden is not absolutely influenced by the level of the burden, but, rather, it is influenced by equity [27, 66]. This study examines the level of tax burden and the taxation specified by the fairness principle and analyzes the effects of taxation on the fiscal sustainability of the welfare state. In addition, the impact of welfare expenditures on fiscal sustainability may change according to tax structure characteristics. Even if increases in welfare expenditures negatively affect national finances, the public may be willing to accept

<sup>7</sup> In the process of estimating the fiscal space of the welfare state not only are the demand factors reflected, which are likely to drive welfare expenditures. In this situation, if these variables included to estimate fiscal sustainability are used, there is the possibility that the endogeneity problem will occur. Therefore, it is necessary to include variables with high relevance to welfare expenditures while minimizing the problem of endogeneity.


Private contributions are generally designed to benefit contributors and are not reflected in government finances, but they can have a positive impact on the maintenance of public welfare programs. Thus, this study uses the share of social security contributions and the share of

To identify the simultaneous equations model, the second equation, which has welfare expenditures as a dependent variable, requires additional exogenous variables, excluding the fiscal

by introducing the generosity of the public pension, unemployment insurance, and disease insurance of the Comparative Welfare Entitlement Dataset 2 (CWED2). These variables are calculated by taking into account the replacement rate, qualifications, scope or coverage, and

In the first equation, where fiscal space as the proxy of fiscal sustainability is a dependent variable, welfare expenditures have a negative impact on the fiscal sustainability of the welfare state at a statistically significant level. Moreover, although the magnitude of the negative impact of welfare spending in the lagged term is somewhat smaller, the increase in welfare spending in the medium term tends to lower fiscal space even further. On the other hand, the results of the second equation with welfare expenditures as a dependent variable demonstrate that welfare expenditures increase as the fiscal space increases at a statistically significant level in the medium-to-long term. This supports the argument that it is essential to secure

If we look only at the results of the first equation, it may be argued that public welfare spending must be reduced, because welfare spending lowers the nation's fiscal space. However, considering the political resistance that may be caused by the reduction of welfare expenditures, it is necessary to examine how financial resources can positively influence fiscal sustainability. At first, increase of tax revenue may offset the negative impact of welfare expenditures on the fiscal sustainability of the welfare state as well as positively affect the fiscal sustain-

It is noted that the perception of tax burden is not absolutely influenced by the level of the burden, but, rather, it is influenced by equity [27, 66]. This study examines the level of tax burden and the taxation specified by the fairness principle and analyzes the effects of taxation on the fiscal sustainability of the welfare state. In addition, the impact of welfare expenditures on fiscal sustainability may change according to tax structure characteristics. Even if increases in welfare expenditures negatively affect national finances, the public may be willing to accept

In the process of estimating the fiscal space of the welfare state not only are the demand factors reflected, which are likely to drive welfare expenditures. In this situation, if these variables included to estimate fiscal sustainability are used, there is the possibility that the endogeneity problem will occur. Therefore, it is necessary to include variables with high

In this study, it is possible to identify the model

private contributions as proxies of the benefit principle.

*3.3.2.4. Measurement of the generosity of the welfare system*

**4. Determinants of fiscal sustainability in welfare state**

fiscal space for the continuation of the welfare state in the long term [5].

relevance to welfare expenditures while minimizing the problem of endogeneity.

sustainability variable with endogeneity.<sup>7</sup>

waiting period [87, 88] (**Table 4**).

112 Taxes and Taxation Trends

ability of the welfare state (**Table 5**).

7


unfairness of disparity. In this way, it is difficult to say the more progressive taxation makes

How Does a Welfare State achieves Fiscal Sustainability? A Study of the Impact of Tax Equity

http://dx.doi.org/10.5772/intechopen.72527

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However, if progressive tax burdens are recognized to be unfair, their impact may vary, because the excessive burden can foster tax evasion [67]. As it is actually known, in 1970s, taxes were raised faster than income, political rebellion became fierce, and most high-income countries stopped raising income taxes to prevent capital from being exported abroad (businesses) and the emigration of productive workers. The problem is that lowering the tax burden on capital raises the risk of hindering horizontal equity with labor taxation and the reduction of tax progressivity [68]. In this manner, if the ability to pay principle is not guaranteed, it is possible to both diminish tax progressiveness and increase the possibility of tax

This is because vertical equity and horizontal equity are inseparable. Both principles have goals that seek to achieve, and one principle cannot replace the other. In other words, inequalities caused by each equity principle are not offset by the achievement of equity through other equity improvements, so that each principle must be resolved directly to the unfairness of the respective side [69]. When vertical equity does not guarantee tax breaks for capital (businesses) and high-income earners, the fair burden condition may be violated, which will enhance the tax resistance of the people and promote tax evasion, even if horizontal equity is raised. Therefore, fairness of the burden according to the ability to pay can be realized when horizontal equity and vertical equity realize their respective goals. Taxation will then work to

On the other hand, in terms of the benefit principle, the increase of social security contributions has a positive effect on the fiscal sustainability of the welfare state and also has the effect of offsetting the negative impact of welfare expenditures on fiscal sustainability. In addition, the increase of mandatory private contributions positively affects fiscal sustainability, even though this is not included in the government's finances. These public finance sources related to the benefit principle carry high political acceptability, because it is easy to secure political support for the burden in terms of direct benefit to the person [89]. In addition, private mandatory contributions can alleviate the fiscal burden of a country without public welfare efforts. Therefore, in order to secure the fiscal sustainability of the welfare state, it appears necessary to diversify the financial structure of the welfare state by making appropriate use

This study identifies determinants of fiscal sustainability of the welfare state by focusing on tax structure. As confirmed by the results of the study, it is essential to secure financial resources to maintain the welfare state. In the short term, fiscal space may not drive the expansion of welfare expenditures, but it nonetheless leads to this in the medium-to-long term. The problem is that an increase in welfare spending may worsen fiscal sustainability, and it is not always an appropriate solution to reduce welfare expenditures in order to increase fiscal space, which is in keeping with the arguments of welfare state opponents. It is impossible

always the more tax avoidance of the high-income class [67].

contribute positively to fiscal sustainability.

of both social security contributions and private contributions.

avoidance.

**5. Conclusion**

**Table 5.** Determinants of fiscal sustainability on welfare state.

the financial burden in the long run by recognizing the tax burden differently, considering the benefits of the fiscal expenditure and the fairness of the tax burden [61, 74]. For example, a fair tax burden may offset the negative effects of welfare spending and may also have a positive impact on fiscal sustainability. For this reason, this study focuses on the moderating effect of the tax structure on the relationship between welfare expenditures and fiscal sustainability, as well as the direct effect of the tax structure on fiscal sustainability.

Specifically, the gap in the tax base, especially the gap between labor taxation and consumption taxation, hinders the fiscal sustainability of the welfare state in terms of horizontal equity. In addition, the negative effect of welfare expenditures on fiscal sustainability tends to become larger as the gap between labor and consumption increases. On the other hand, the direct effect of the gap between labor and capital taxation does not have a statistically significant effect. Although the impact of the gap between labor and capital taxation on fiscal sustainability is not statistically significant, the negative effects of welfare expenditures on fiscal sustainability intensify when tax equity is not guaranteed. In other words, if the tax burden is not distributed fairly among the tax base (labor, capital, and consumption), it is difficult to guarantee the fiscal sustainability of the welfare state.

Second, the effect of the level of vertical equity on the fiscal capacity of the welfare state is mixed. The increase of the progression in low-income groups has a statistically significant negative impact on fiscal capacity, while the increase of progressivity in the high-income group is not statistically significant, although it demonstrates a positive impact. In addition, the latter also alleviates the negative impact of welfare expenditures at a statistically significant level. Related to this, it is worth noting that severe income tax burdens on low-income households may have a negative impact on improvements to the fiscal sustainability of the welfare state.

It is important to point out the relationships between the ability to pay principle and fiscal sustainability of the welfare state. This is also associated with mixed analysis results in vertical equity. The golden age of the welfare state, from 1930 to 1960, had been supported by the ability to pay principle. As the principle of social justice based on equity was expanded, demand for redistribution expanded, and income tax assumed stronger progressive characteristics. This is due to the fact that in the reality of social ills caused by the monopoly of the capital growth process, the state faithfully tries to tame the working class and to correct the unfairness of disparity. In this way, it is difficult to say the more progressive taxation makes always the more tax avoidance of the high-income class [67].

However, if progressive tax burdens are recognized to be unfair, their impact may vary, because the excessive burden can foster tax evasion [67]. As it is actually known, in 1970s, taxes were raised faster than income, political rebellion became fierce, and most high-income countries stopped raising income taxes to prevent capital from being exported abroad (businesses) and the emigration of productive workers. The problem is that lowering the tax burden on capital raises the risk of hindering horizontal equity with labor taxation and the reduction of tax progressivity [68]. In this manner, if the ability to pay principle is not guaranteed, it is possible to both diminish tax progressiveness and increase the possibility of tax avoidance.

This is because vertical equity and horizontal equity are inseparable. Both principles have goals that seek to achieve, and one principle cannot replace the other. In other words, inequalities caused by each equity principle are not offset by the achievement of equity through other equity improvements, so that each principle must be resolved directly to the unfairness of the respective side [69]. When vertical equity does not guarantee tax breaks for capital (businesses) and high-income earners, the fair burden condition may be violated, which will enhance the tax resistance of the people and promote tax evasion, even if horizontal equity is raised. Therefore, fairness of the burden according to the ability to pay can be realized when horizontal equity and vertical equity realize their respective goals. Taxation will then work to contribute positively to fiscal sustainability.

On the other hand, in terms of the benefit principle, the increase of social security contributions has a positive effect on the fiscal sustainability of the welfare state and also has the effect of offsetting the negative impact of welfare expenditures on fiscal sustainability. In addition, the increase of mandatory private contributions positively affects fiscal sustainability, even though this is not included in the government's finances. These public finance sources related to the benefit principle carry high political acceptability, because it is easy to secure political support for the burden in terms of direct benefit to the person [89]. In addition, private mandatory contributions can alleviate the fiscal burden of a country without public welfare efforts. Therefore, in order to secure the fiscal sustainability of the welfare state, it appears necessary to diversify the financial structure of the welfare state by making appropriate use of both social security contributions and private contributions.
