CHAPTER 1
taxes. The rise in pension spending explains the bulk of the increase in the size of governments in Europe, with health-related spending accounting for the remainder. Several European countries are implementing pension reforms, including increasing the retirement age, reducing early retirement benefits, and reducing replacement rates. In many cases the EU’s new members and Eastern European neighbors spearheaded these reforms as they faced the challenge of rapid aging with far lower average incomes and productivity. Nonetheless, replacement rates in Europe tend to be considerably more generous than in other high-income countries, most notably Canada, Japan, and the United States. The comparison with Japan is particularly instructive because Japan is the one high-income country that shares Europe’s predicament of a labor force that is rapidly declining in size. In most European countries, pension reform remains unfinished business. The large role of government in providing basic public services and the generosity of the social security system comes with a higher tax burden. Corporate tax rates decreased over the past two decades, leading to more uniform effective rates in Europe and among all developed countries. Personal income tax rates still vary from other parts of the world and even within Europe, especially when the new EU member states are included. Europe’s high payroll taxes and marginal income taxes lead to the largest difference in the world between gross and net wages. One implication of this gap is that the post-tax distribution of earnings is more equal in Europe (figure 1.14). Another implication is that work incentives are weaker. As a share of their GDP, European countries do not have higher expenditures for health or education than other high-income countries. The role of the government in providing and financing these services, however, tends to be greater in Europe. On average, governments finance three-quarters of all health
Figure 1.14: Redistribution through the tax and transfer system is more pronounced in Europe (Gini indices, 2000s)
a. For Australia and New Zealand, the latest available data are from 1994 and 1997, respectively. b. Japan’s data are from 1993. Note: “EU cand.” refers to EU candidate countries and “E. prtn.” refers to EU eastern partnership countries. Source: WDI; and OECD Income Distribution and Poverty Database.
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