*3.3.2.1. Measurement of horizontal equity*

Horizontal equity identifies the tax rate gaps between labor and assets and labor and consumption, which are major tax sources because guaranteeing horizontal equity means that equity is ensured among the tax bases [69]. In particular, despite the weakening of the tax base, labor taxation is the most basic tax in all countries, so horizontal equity is defined based on the labor tax. Specifically, each tax rate on the labor, capital, and consumption of households is derived, and the tax rate differences between labor and capital taxation and labor and consumption tax are calculated based on the method proposed by Macdaniel [79].6 According to the study, the government's tax revenue is divided into labor tax, capital tax, private consumption tax, and private investment tax. Moreover, the average tax rate of each tax base is calculated by dividing each tax revenue from each source into the corresponding tax sources [79].

**Categories Variables Definition Sources**

Horizontal equity

Fiscal sustainability Fiscal space OECD

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

nominal GDP

Tax burden Total tax revenue/nominal GDP OECD Tax

labor and capital

Vertical equity ((1 − marginal tax rate of average

nominal GDP

nominal GDP

Fiscal sustainability Fiscal space OECD

period

Gap between effective tax rate on

Gap between effective tax rate on labor and consumption

wage 67%)/(1 − marginal tax rate of average wage 100%)) − 1

((1 − marginal tax rate of average wage 100%)/(1 − marginal tax rate of average wage 167%)) − 1

Mandatory private contribution/ total social security revenue

considering the replacement rate, qualifications, scope or coverage,

considering the replacement rate, qualifications, scope or coverage,

and waiting period

and waiting period

Index of unemployment insurance considering the replacement rate, qualifications, scope or coverage, and waiting

Welfare expenditures Total public welfare expenditures/

Benefit principle Social security contribution/

Welfare expenditures Total public welfare expenditures/

Generosity of public pension Index of public pension

Generosity of sickness insurance Index of sickness insurance

Generosity of public unemployment insurance

**Table 4.** Variables for estimating determinants of fiscal sustainability of welfare state.

National account

111

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OECD Social Expenditure Statistics

Dataset

OECD National account

Nickell [86] OECD Tax Dataset

OECD Revenue Statistics: financing of social security benefits

OECD Social Expenditure Dataset

National account

Scruggs et al. [88] CWED2

Equation. 1 Dependent variable

Equation 2 Dependent variable

> Independent variables

> Independent variables

> > Ability to pay principle

#### *3.3.2.2. Measurement of vertical equity*

Vertical equity, one aspect of the ability to pay principle, is measured by the relative ratio of the marginal tax rate among income groups. In the comparison of tax progressivity among countries, a structural approach has been utilized to compare statutory tax rates, as well as comparisons within specific income groups. In this study, the structural approach is used for cross-country comparisons, although it is recognized as a valid criticism that it is difficult to reflect differences in taxable income using this [84, 85]. This study reflects the differences between progressivity in the low-income class (67% of the average wage and the average wage) and progressivity in the high-income class (comparison between the average wage and the average wage of 167%) considering data accessibility. In addition, this study measures the actual burden level, excluding benefits by subtracting the transfer of cash so as to more accurately measure the progressivity. For the values which are calculated as mentioned above, the higher the value, the stronger the progressivity, and the lower the value, the more regressive it is. This approach has the advantage of reflecting the degree of progressivity. The marginal tax rate data among the income groups for estimates of progressivity were used by Nickell [86] and the OECD Taxing Wages Database. That database provides marginal tax rates for OECD countries between 1960 and 2004. On the basis of this, the OECD has calculated the marginal tax rates of each country since 2000, and this study combines both datasets.

#### *3.3.2.3. Measurement of the benefit principle*

The benefit principle is specified by the share of social security contributions in GDP [73]. The social security contribution is a welfare state resource that is provided through contributions made by both employers and employees. This is a fixed use, and it is based on a burden corresponding to the benefits, so it is related to the benefit principle [73]. In addition, the proportion of private contributions to welfare resources supplements the benefit principle.

<sup>6</sup> The reason for using this method is as follows. First, it uses only one dataset, OECD national accounts, so it resolves the problem of differences in reflection times in the figures according to the differences in accounting methods by using two datasets, OECD national accounts and revenue statistics, similar to the existing studies of Mendoza et al. [81] and Carey and Rabesona [82, 83]. Second, this method overcomes the overestimation of consumption tax, one of the limitations of existing methods caused when consumption and investment taxes are not separated. In this method, the consumption tax remains separate from taxation on investments so that it can be more accurately measured.

How Does a Welfare State achieves Fiscal Sustainability? A Study of the Impact of Tax Equity http://dx.doi.org/10.5772/intechopen.72527 111


*3.3.2.1. Measurement of horizontal equity*

110 Taxes and Taxation Trends

*3.3.2.2. Measurement of vertical equity*

*3.3.2.3. Measurement of the benefit principle*

6

Horizontal equity identifies the tax rate gaps between labor and assets and labor and consumption, which are major tax sources because guaranteeing horizontal equity means that equity is ensured among the tax bases [69]. In particular, despite the weakening of the tax base, labor taxation is the most basic tax in all countries, so horizontal equity is defined based on the labor tax. Specifically, each tax rate on the labor, capital, and consumption of households is derived, and the tax rate differences between labor and capital taxation and labor and consumption tax

government's tax revenue is divided into labor tax, capital tax, private consumption tax, and private investment tax. Moreover, the average tax rate of each tax base is calculated by divid-

Vertical equity, one aspect of the ability to pay principle, is measured by the relative ratio of the marginal tax rate among income groups. In the comparison of tax progressivity among countries, a structural approach has been utilized to compare statutory tax rates, as well as comparisons within specific income groups. In this study, the structural approach is used for cross-country comparisons, although it is recognized as a valid criticism that it is difficult to reflect differences in taxable income using this [84, 85]. This study reflects the differences between progressivity in the low-income class (67% of the average wage and the average wage) and progressivity in the high-income class (comparison between the average wage and the average wage of 167%) considering data accessibility. In addition, this study measures the actual burden level, excluding benefits by subtracting the transfer of cash so as to more accurately measure the progressivity. For the values which are calculated as mentioned above, the higher the value, the stronger the progressivity, and the lower the value, the more regressive it is. This approach has the advantage of reflecting the degree of progressivity. The marginal tax rate data among the income groups for estimates of progressivity were used by Nickell [86] and the OECD Taxing Wages Database. That database provides marginal tax rates for OECD countries between 1960 and 2004. On the basis of this, the OECD has calculated the

marginal tax rates of each country since 2000, and this study combines both datasets.

The benefit principle is specified by the share of social security contributions in GDP [73]. The social security contribution is a welfare state resource that is provided through contributions made by both employers and employees. This is a fixed use, and it is based on a burden corresponding to the benefits, so it is related to the benefit principle [73]. In addition, the proportion of private contributions to welfare resources supplements the benefit principle.

The reason for using this method is as follows. First, it uses only one dataset, OECD national accounts, so it resolves the problem of differences in reflection times in the figures according to the differences in accounting methods by using two datasets, OECD national accounts and revenue statistics, similar to the existing studies of Mendoza et al. [81] and Carey and Rabesona [82, 83]. Second, this method overcomes the overestimation of consumption tax, one of the limitations of existing methods caused when consumption and investment taxes are not separated. In this method, the consumption

tax remains separate from taxation on investments so that it can be more accurately measured.

According to the study, the

are calculated based on the method proposed by Macdaniel [79].6

ing each tax revenue from each source into the corresponding tax sources [79].

**Table 4.** Variables for estimating determinants of fiscal sustainability of welfare state.

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 private contributions as proxies of the benefit principle.

**Dependent variables**

Fiscal sustainability Equation 1

**Independent variables Model 1 Model 1**

Gap between effective tax rate on labor and capital

Progressivity (low income

Progressivity (high income

Welfare expenditures \* tax

Welfare expenditures \* gap between effective tax rate on

Welfare expenditures \* gap between effective tax rate on labor and consumption

Welfare expenditures \* progressivity (low income

Welfare expenditures \* progressivity (high income

Welfare expenditures \* mandatory private contribution

Generosity of public unemployment insurance

Generosity of sickness

insurance

Welfare expenditures \* social security contribution

Mandatory private contribution

labor and capital

group)

group)

burden

group)

group)

Welfare expenditures Equation 2

Gap between effective tax rate on labor and consumption

Welfare expenditure (*t* − 1) −4.32 0.35\*\*\* −3.74 0.34\*\*\* Welfare expenditure (*t* − 5) −1.79 0.39\*\*\* Tax burden 1.01 0.50\* 1.84 0.52\*\*\*

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

Social security contribution 3.80 1.21\*\* 4.75 1.17\*\*\*

Constant term 139.13 24.05\*\*\* 141.22 23.26\*\*\*

Fiscal sustainability (*t* − 1) −0.07 0.01\*\*\* −0.07 0.01\*\*\* Fiscal sustainability (*t* − 5) 0.05 0.01\*\*\* 0.05 0.01\*\*\* Generosity of public pension 0.44 0.16\*\* 0.40 0.16\*

Constant term 11.67 2.51\*\*\* 11.66 2.52\*\*\*

0.42 0.16\* 0.42 0.17\*

0.65 0.24\*\* 0.65 0.24\*\*

**Coefficient Standard error Coefficient Standard error**

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113

1.64 2.23 −2.66 4.07

−83.60 22.70\*\*\* −131.0 22.53\*\*\*

−23.78 8.80\*\* −31.50 9.79\*\*

4.37 7.72 −0.18 7.51

0.97 0.22\*\*\* 0.99 0.21\*\*\*

0.24 0.05\*\*\*

−4.32 3.50

−11.85 3.97\*\*

3.36 2.04

−0.77 1.56

0.29 0.12\*

0.08 0.04\*

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

To identify the simultaneous equations model, the second equation, which has welfare expenditures as a dependent variable, requires additional exogenous variables, excluding the fiscal sustainability variable with endogeneity.<sup>7</sup> In this study, it is possible to identify the model 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 waiting period [87, 88] (**Table 4**).
