**3. Research method**

Basically, tax is a representative resource mobilization tool of the advanced welfare state. Therefore, the level of tax burden in terms of public revenue should be discussed in relation to the fiscal sustainability of the welfare state. In order to cover welfare expenditures, a certain level of tax burden must be guaranteed, but if the tax burden is too high, it is not easy to increase the burden level [19, 65]. There are many reasons for the increase in incentives for tax avoidance and tax evasion. On the other hand, too low level of tax burden can also negatively impact fiscal sustainability. This is because there is a high possibility that sufficient financial

In addition, the structural characteristics of tax, especially tax equity, should be considered as the main factors. Because taxation inevitably violates the private ownership of a member, a lack of reasonable grounds for who owes taxes can lead to tax resistance and promote social conflict and division. Therefore, taxes must be imposed on the basis of justifiable grounds to secure political support for welfare states [12]. Indeed, the views on the taxation of the public are determined not by the level of burden but by the fairness of burden [27, 66]. The fairness of taxation can be defined as the principle of the ability to pay and the benefit principle. The former is the view that members of society are obliged to pay taxes regardless of the benefits they receive from the state as a member of the state. Accordingly, it is fair and desirable to pay taxes according to the ability to pay or to charge. On the other hand, the principle of benefit attaches importance to the exchange of benefits from tax and public goods, with the view that the taxpayer will pay the benefits of the provision of national services. In other words, it is fair to pay fair compensation for benefits.

Tax on the basis of each principle can have a different impact on the fiscal sustainability of a welfare state. First, in relation to the principle of ability to pay, direct taxation with a high tax rate can have a negative impact on economic growth by lowering incentives for labor and high tax evasion in the high-income class. On the basis of this, the enhancement of tax progressivity may hinder the fiscal sustainability of the welfare state. However, it is also true that people are not always opposed to high-level taxation [67]. In addition, the Progressive Tax System can be designed to lower income inequality by designing the higher income group to pay a higher tax burden than the low-income group, thus contributing to social sustainability by preventing

conflicts between taxpayers and beneficiaries due to worsening income distribution.

the level of equity is raised to the level of horizontal equity.

Meanwhile, the horizontal equity, one part of ability to pay, is also considered. Related to this, the possibility of taxation of capital and property is lowered due to the intensification of tax competition caused by globalization [68], and advanced welfare countries have shown a tendency to rely on a consumption tax rather than an income tax. Unlike in the past, the gap between the labor and the capital is significantly increasing, while the gap between the labor and the consumption is significantly decreasing. Recalling that vertical equity and horizontal equity are inseparable, and that inequity on one side is not offset by the achievement of equity through other principles [69], the inhibition of confidence that the tax burden is fairly distributed can make it difficult and may not only lead to a lack of financial resources to support the welfare state, but also to difficulties in obtaining political support. Thus, the widening gap between tax sources have a negative effect on the fiscal sustainability of the welfare state as

On the other hand, social security contributions and the contributions of the private sector are closely related to the principle of benefit. This is mainly used for specific social security

resources are not available for public expenditure.

104 Taxes and Taxation Trends

#### **3.1. Analysis target and timing**

The analysis of national finances should incorporate careful selection of the analysis target because analysis results may be different depending on which country is analyzed. Because, there is a huge gap between the high- and low-income countries' socioeconomic development levels, especially in terms of the level of public expenditures, the taxation capacity, and the tax structure, so it is necessary to analyze the two groups separately. This chapter analyses the 17 OECD countries, and considering the possibility of data access and the analysis of OECD major countries is reasonable in order to draw implications in the establishment of a welfare state with a financial balance. Specifically, the analysis includes Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

Next, this chapter analyzes the fiscal sustainability of welfare states over the course of 28 years, from 1986 to 2013, while the independent variables, including tax structure and welfare expenditures, are based on the period from 1985 to 2012, lagged term (*t* − 1), considering temporal precedence as a requirement for causality.3 Those OECD countries have undergone a series of welfare and tax reforms to alleviate the burden of national financing, having experienced severe economic downturns during the mid to late 1970s. Since the effects of reform are not immediately

<sup>3</sup> This is based on the fact that the expenditures for that year are carried out in accordance with the previous year's budget plan. The analysis is also conducted by adding value from 5 years prior to reflect the medium-term fiscal plan in highincome countries as a 5-year plan. In the determinants of fiscal sustainability of the welfare state, the correlation between welfare expenditures and fiscal capacity may not be reflected within a short time frame. In particular, the impact of fiscal capacity on welfare expenditures is likely to be seen in the medium term, because in high-income countries, the level of public expenditures is usually determined through the medium- and long-term financial management of the country.

apparent, but, rather, come after a certain period of time, this study has limited its analysis to late 1980s, specifically since 1986 (independent variables since 1985). In addition, until early 1990s, most advanced welfare states demonstrated a relatively moderate increase in national debt. However, since mid-1990s, sovereign debt has soared, and concerns about the national debt have become more widespread since the 2008 global financial crisis. Therefore, it is possible to derive timely policy implications for ensuring the fiscal sustainability of the welfare state by analyzing the period when the national debt had soared and a widespread financial crisis occurred.

an important role in resource mobilization to cover future spending, as well as cushioning against unexpected risks [77, 78]. In other words, the issue of fiscal space is a question of whether countries can finance their obligations, including social security, without sacrificing economic growth and stability based on fiscal sustainability [5, 50]. Therefore, fiscal space can

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

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

107

In order to derive the abovementioned fiscal space as shown in **Figure 1**, it is necessary to estimate the fiscal reaction function and select the appropriate gap between the interest rate and the growth rate [57]. This is because it is necessary to determine the debt limit of each country on the basis of the intersection of the estimated base on the fiscal reaction function and the interest repayment schedule. This study estimates the fiscal reaction function through pooled time series analysis and uses a vector autoregressive model for estimation to establish the gap between the appropriate interest rate and the growth rate. The description of variables used

Next, one of the most important points to be considered in determining the national debt limit, along with the estimation of the fiscal reaction function, is how to define the long-term

similar to the works of Polito and Wickens [62, 63]. This is because it not only avoids arbitrary problems, but also reflects the endogenous relationship between the interest rate and the national debt level (**Table 2**). In this study, the autoregressive model is used to model the endogenous relationship between the interest rate and the national debt, adding government revenue, government spending, debt, the economic growth rate, the inflation rate, and short- and long-term interest rates [62, 63]. The gap between these estimates and the average real growth rates of the countries from 1985 to 2013 are used to calculate the debt limit and determine fiscal space based on this. The contents and data sources of the variables used for

The second dependent variable is public welfare expenditures. This is the level of public (general government) social welfare spending that reflects public welfare efforts or the level of benefits enjoyed by the public. Total public welfare expenditures divided by the gross domestic product is used to control differences in the welfare expenditure level according to the

The dependent variable is the primary balance, and the independent variables are the financial factors (national debt, public welfare expenditures, output gap, inflation rate), the economic structural factors (unemployment rate, service industry ratio, portion of involuntary part-time work, economic openness, aging rate, future old age portion), and political and financial institutional factors (election, change of ideology, mandatory political system, concentration index, fiscal rule index). In this study, it is based on the works of Ostry et al. [56] and Ghosh et al. [57], but some variables are

Ostry et al. [56] determined long-term interest rates in two ways. The first assumes that the observed interest rate itself reflects the perceived probability of bankruptcy of a country, so the current market rate is used as the long-term interest rate. In this case, it is possible to overestimate the maximum value of sustainable debt by overlooking the fact that the interest rate rises as the debt level approaches its limit, and the risk of bankruptcy increases. An alternative method of overcoming this limitation is to use the interest rate, which is calculated by taking into account the endogenous relationship between debt levels and interest rates. Specifically, they used the calculated interest rate, assuming a recovery rate of 90% when bankruptcy occurred. Alternative methods which they used help to accurately estimate fiscal space by reflecting endogenous relationships between interest rates and macroeconomic variables. However, the abovementioned study does not provide a clear basis for assumptions used in interest rate estimation. Therefore, it is not free of the problems caused by an arbitrary definition of the recovery rate [80]. In order to overcome these limitations, this study

4

This study estimates the interest rate through vector autoregulation (VAR),

be a useful tool in examining the fiscal sustainability of the welfare state.

for estimating the fiscal reaction function is shown in **Table 1**.

estimating the fiscal reaction function are shown in **Table 3**.

level of economic scale by country.

excluded in consideration of multicollinearity.

uses the estimates through VAR.

4

5

interest rate [56].5
