Revenue Portfolio Design, Fiscal Network Position, and Inequality: Evidence from Europe

In the modern world, a nation's tax system is often viewed as a domestic affair, a collection of rules written in a capital city to fund schools, hospitals, and roads. Economists have long understood that the specific mix of taxes matters deeply for how fair a society feels. A system that relies heavily on taxes paid by the wealthy tends to reduce the gap between rich and poor, while a system leaning on taxes paid by everyone, regardless of income, often widens that gap. For decades, the standard assumption was that each country solved this puzzle in isolation, balancing its own need for money against its desire for equality. However, in a connected world like Europe, where borders are open for trade and people move freely, a country's tax choices do not exist in a vacuum. They sit within a complex web of other nations' choices, creating a landscape where what one country does is constantly compared to what its neighbors do.

This reality forms the backdrop for a new study by researchers at the Aristotle University of Thessaloniki, who set out to understand how the shape of a country's tax system interacts with the tax systems of its neighbors to influence inequality. They looked at twenty-nine European economies over a period of twenty-eight years, from 1995 to 2022. Instead of just counting how much tax a country collected, they mapped the specific ingredients of each nation's tax recipe. They treated every country's tax system as a unique profile, comparing it to every other country to see which ones looked most alike. By doing this, they built a map of fiscal resemblance, a network where countries are linked not by geography, but by how similar their tax structures are. On this map, some countries sit in the middle, surrounded by many peers with nearly identical systems, while others sit on the edges, with unique structures that stand apart from the crowd.

The researchers discovered that a country's position on this map is just as important for inequality as the taxes it actually collects. They found two distinct forces at work. The first is the diversity of a country's own tax portfolio. When a government spreads its revenue across many different types of taxes—mixing income taxes, property taxes, and consumption taxes—it tends to have lower levels of inequality. This diversification acts as a buffer, preventing the system from becoming too dependent on any single tax that might hurt the poor or be easily avoided by the rich. This is a lever that national governments can pull on their own; by reforming their own tax codes to be broader and more balanced, they can directly improve the fairness of their society.

The second force is more structural and harder to control. It is the position a country holds within the European tax network. The study found that countries whose tax systems closely resemble those of many other nations—those sitting in the center of the network—tend to have higher levels of inequality. These central countries face intense competitive pressure. Because their tax systems are so similar to their neighbors, any attempt to raise taxes on the wealthy or change the rules for redistribution is immediately scrutinized and compared. This creates a constraint, making it politically and economically difficult to deviate from the common template. In contrast, countries with more unique, idiosyncratic tax systems have more room to maneuver. They are not as tightly bound by the expectations of their peers, allowing them to design more redistributive policies without fear of immediate capital flight or political backlash.

The researchers also examined the role of tax compliance, specifically looking at the gap between the value-added tax that countries should collect and what they actually collect. They found that when a country's fiscal neighbors have large gaps in their tax collection, it tends to increase inequality at home. This suggests that tax enforcement is a shared environment; if neighbors tolerate evasion, it weakens the rules for everyone, making it harder for any single country to maintain a fair system. However, this effect appears to be a long-term structural issue rather than a direct, immediate transmission of inequality from one country to another.

Perhaps the most significant finding is what the study ruled out. The data showed that inequality does not simply spread from one country to another like a contagion. It is not the case that if a neighbor becomes more unequal, a country automatically becomes more unequal. Instead, the influence comes from the structural exposure of the tax system itself. The study confirmed that the similarity of tax structures creates a competitive environment that shapes what policies are possible, rather than simply copying the outcomes of those policies. This distinction is crucial because it means that the solution is not just about copying successful neighbors, but about understanding the structural constraints of the network.

The implications of these findings are clear for policy makers. While a government can independently choose to diversify its tax portfolio to reduce inequality, it cannot unilaterally change its position in the European fiscal network. A country cannot simply decide to be less central or less similar to its neighbors without making drastic changes that might be politically or economically impossible. The study suggests that reducing inequality in Europe requires a coordinated approach. Because the competitive pressure that drives inequality is a feature of the entire network, fixing it requires action across the bloc, not just within individual capitals. The research highlights that in an integrated economy, the design of a tax system is not just a domestic calculation but a strategic move within a larger, interconnected game where the position of every player affects the outcome for all.