Fiscal competition and activist social policy

Abstract

More than a century ago national governments in Europe started assuming responsibility on a broader scale for safeguarding the population against major risks of life, such as sickness and old-age poverty, thus transcending the boundaries of a regulatory minimum state. The second half of the twentieth century witnessed the expansion and maturation of modern welfare states around the two core aims of risk insurance and distributional equity (see Tanzi 2002: 119). As observed by Wildasin (2000: 341), the development of social policy can be seen to "reflect the outcome of a democratic policy making process that has not been prepared to accept the market-determined distribution of income in an unaltered form." Recent survey evidence shows that the welfare state is still well rooted in equity preferences and risk aversion of European citizens at large (Osberg and Smeeding 2005, Heien 2000). At the same time concern has been expressed that factor market integration and the ensuing fiscal competition in Europe create pressures for a downward adjustment of welfare states. More specifically, it is generally acknowledged that tax competition makes it much more difficult for governments to sustain high levels of redistributive activity. Against this backdrop, the contribution studies how social policies and tax policies in the European Union are related. More specifically, it inquires into potential adjustments when fiscal competition via undermining national social policies creates a downward trend on social standards in Europe. In contrast to the greater part of the public finance literature, the emphasis of this contribution is on active rather than on passive integration of social policy. Active social policy integration results from activities to harmonise or to coordinate social policies at the European level. Passive social policy integration, instead, is an adaptation of welfare systems as a response to indirect pressures on the welfare state arising from, e.g., market requirements or concerns of competitiveness (Leibfried and Pierson 2000). As a starting point, Section 4.2 will depict cross-national differences in social policy in the EU. Sections 4.3 and 4.4 highlight how these differences might vanish in the context of unlimited tax competition. Against this backdrop, we will discuss the potential of coordination as well as harmonisation of social policy to cope with fiscal competition in the 4.5 Section. In doing so, we will pay particular attention to the extent to which a more concerted approach to social policy might induce a backlash on tax policy. The final section summarizes the discussion and defines an agenda for future research. © Springer-Verlag Berlin Heidelberg 2007. All rights are reserved.