TAX SCHEDULE CHANGES AND DISCOUNT BOND PRICES

Research on the impact of marginal tax changes on bondholder wealth focuses on changes along a given tax schedule. In this paper the valuation consequences of changing the tax schedule are analyzed. Although previous researchers show that the price of all discount bonds falls if the marginal ordinary income tax rate increases along a tax schedule, it is found that this result holds only under specific conditions when the tax schedule changes. Various comparative statics are discussed.     

A Cost-Benefit Analysis of the Thailand Taxpayer Survey

We investigate whether more resources should be devoted to a Thai tax enforcement program which is aimed at bringing small businesses into the tax system. We show that the appropriate criteria for determining whether more resources should be devoted to tax enforcement is whether the Atkinson–Stern condition for the optimal provision of a publicly-provided good is satisfied, or equivalently, whether the marginal cost of finds obtained through additional tax enforcement, SMCF_p, is less than the marginal cost of funds obtained through raising tax rates, SMCF_t. In our base case scenario, the SMCF_p is 11.60 which exceeds our estimate of the SMCF_t for an across-the-board increase in income tax rates on wage earners. The use of pro-poor distributional weights makes expanding the survey less attractive if the alternative way of obtaining additional tax revenue is an across-the-board income tax rate increase, while aversion to tax evasion makes it more attractive.     

Tax coordination with different preferences for public goods: Conflict or harmony of interest?

The paper analyzes strategic commodity taxation in a model with trade in a single private good that is simultaneously imported by consumers of a high-tax country and exported by its producers. Conditions for the existence of a Nash equilibrium are given, and an asymmetry is introduced through different preferences for public goods. Two tax coordination measures are discussed—a minimum tax rate and a coordinated increase in the costs of cross-border shopping. It is shown that tax coordination generally benefits the high-tax country while the low-tax country will gain only if the intensity of tax competition is high in the initial equilibrium or if governments are pricesensitive toward the effective marginal costs of public good supply.     

The Elasticity of Taxable Income in New Zealand*

This paper reports estimates of the elasticity of taxable income with respect to the net‐of‐tax rate for New Zealand taxpayers. The relative stability of the New Zealand personal income tax system, in terms of marginal rates, thresholds and the tax base, provides helpful conditions for deriving these estimates. The elasticity of taxable income was estimated to be substantially higher for the highest income groups. Changes in the timing of income flows for the higher income recipients were found to be an important response to the announcement of a new higher rate bracket. The marginal welfare costs of personal income taxation were consistent across years, being relatively small for all but the higher tax brackets. For the top marginal rate bracket of 39 per cent, the welfare cost of raising an extra dollar of tax revenue was estimated to be well in excess of a dollar. Implications of the findings are that: disincentive effects of high top marginal rates can be substantial even when labour supply responses are small; the welfare costs of increases in top marginal tax rates can be high; and announcement effects of tax policy changes can lead to considerable income shifting between time periods.     

Human capital and optimal positive taxation of capital income

This paper analyzes optimal linear and non-linear taxes on capital and labor incomes in a life-cycle model of human capital investment, financial savings, and labor supply with heterogenous individuals. A dual income tax with a positive marginal tax rate on not only labor income but also capital income is optimal. The positive tax on capital income serves to alleviate the distortions of the labor tax on human capital accumulation. The optimal marginal tax rate on capital income is lower than that on labor income if savings are elastic compared to investment in human capital, substitution between verifiable and non-verifiable inputs in human capital formation is difficult, and most investments in human capital are verifiable so that education subsidies can directly reduce the tax wedge on learning. Numerical calculations suggest that the optimal marginal tax rate on capital income is substantial.     

Second-best income taxation and education policy with endogenous human capital and borrowing constraints

We formulate a two-period life cycle model of saving, labor supply, and human capital investment when individuals differ in their ability and initial wealth. Borrowing constraints result in sub-optimal choices for consumption and investments in human capital. We analyze optimal linear income taxes and education subsidies. The optimal income tax is shown to be positive—even in the absence of any redistributional concerns. A redistributive income tax relaxes borrowing constraints by redistributing resources from the unconstrained to the borrowing constrained stages of the life cycle. The income tax thus alleviates preexisting non-tax distortions in the capital market. Human capital is subsidized on a net basis in the absence of redistributional concerns. Education subsidies help to relax credit constraints and to reduce distortions from explicit and implicit taxes on human capital formation. When redistributional concerns are present, education is subsidized more if this helps to alleviate distortions on labor supply, but is subsidized less if education subsidies have a very regressive incidence. Simulations demonstrate that optimal income taxes are substantially higher when credit constraints are present. Education is generally subsidized on a net basis, and the more so if credit constraints are more severe.     

Environmental taxes on intermediate and final goods when both can be imported

One of the most difficult administrative problems in implementing broad-based environmental taxes concerns the tax treatment of imports, particularly imports of final goods that are producedusing intermediate goods that are taxed domestically. Provided there is no joint production, taxing imported final goods based on the amount of intermediate goods consumed in their domestic production will raise marginal costs by the same amount for domestic and foreign producers. This rule is impossible to implement when final goods are produced as joint products, however, as in the petroleum refining and petrochemical industries. In such cases arbitrary assignments of intermediate good inputs to final goods-for example, on the basis of relative output weight or value-are likely to change the relative marginal costs of domestic and foreign producers.     

Payout Policy and Tax Deferral

Equilibrium in the standard finance model implies that value-maximizing firms make taxable equity payouts, even when deferral effectively allows complete tax escape. Since tax deferral and consumption deferral are inherently jointly supplied goods, an excess aggregate supply of future consumption would result if firms followed conventional wisdom and adopted low or zero payout policies to capture tax deferral benefits. The market provides incentives for firms to supply both taxable payouts and capital gains by overriding any tax deferral advantage, just as it provides incentives for equity financing by overriding the corporate tax advantage of debt in “Debt and Taxes.”     

Laffer effect, gross substitution, marginal cost of public funds and the level property of public good provision

This paper examines the Laffer effect in the Ramsey tax-model with linear consumption taxes and a representative consumer. It is assumed that the private goods and the public good are weakly separable. It is demonstrated that if all of the private goods are weak gross complements to each other, then the Laffer effect does not exist, in other words, higher tax rates can always achieve more tax revenue. In contrast, if all of the private goods are strict gross substitutes, then the Laffer effect does exist. Moreover, if all of the private goods are weak gross substitutes, then the government cannot fully acquire the leisure endowment through taxes on consumption goods. We also show that gross substitution works to raise the marginal cost of public funds.     

Reforming the Direct–Indirect Tax Mix

This paper provides a new framework for evaluating the welfare effects of commodity tax reforms. It is shown that tax reforms are welfare improving if and only if they satisfy the following intuitive property: on average, consumer prices fall for commodities with high marginal excess burdens. The rule is then applied to analyze a shift from differentiated commodity taxation to direct flat-rate taxation of labour income. The welfare impact of such reforms can be decomposed into two effects: (i) the increase in welfare associated with substitution among taxed commodities, and (ii) the loss in welfare associated with substitution between commodities and leisure. On balance, a shift towards direct taxation is desirable when inter-commodity substitution effects are large relative to commodity–leisure substitution effects. The analysis allows us to reconcile the apparently conflicting results of the tax reform and optimal taxation literatures.     

On the design of an optimal non-linear tax/pension system with habit formation

We study the optimal tax/pension design in a two-period model where individuals differ in both productivity and discount rates or projection bias and where their utility of the retirement period consumption is not independent of the earlier standard of living. We consider both welfarist and paternalistic social objectives. The paternalistic government attempts to correct the projection bias by using a higher discount factor. We derive general mathematical expressions that characterize optimal tax/pension design (marginal tax/subsidy rates). They suggest that the pattern of marginal labor income taxes depends on habit formation. Negative marginal labor income tax rates are possible. To gain a better understanding, we examine numerically the properties of an optimal lifetime redistribution policy with habit formation. We find support for non-linear tax/pension program in which some types of individuals are taxed while some are subsidized. The effect of changes in the degree of habit formation is explored in the numerical simulations as well as the implications of different degrees of correlation between skill and projection bias.     

Disability insurance and optimal income taxation

This paper studies the design of disability insurance scheme when agents differ in their privately known productivity. We extend the Diamond and Mirrlees (1978) two period model to allow for agents differing ex-ante in their productivity and characterize the optimal nonlinear tax transfer that maximizes a utilitarian welfare function when per-period earnings and age are observable while individuals’ productivity and health status are not observable. We show that the induced tax/benefit scheme should exhibit a marginal income tax that decreases with age for some agents. A marginal subsidy on the young high productive income may be desirable. While the disability scheme always involves the old low productive agents to be indifferent between working and claiming disability benefits, this result is not always true for the old high productive agents. JEL Classification H55 · H23 · E62     

Decomposing Inequality Changes: Allowing for Leisure in the Evaluation of Tax and Transfer Policy Effects

In this paper, we present two alternative methods of accounting for changes in leisure time in decomposing the inequality effects of tax and transfer policy changes. Three components are identified: tax policy, labour supply responses to tax policy changes and other population effects. The methods are used to decompose inequality changes in Australia between 2001 and 2006. Inequality is first defined in non‐welfarist terms as a function of disposable income: the independent judge places no value on leisure. Then, this is modified to allow for evaluations using a weighted geometric mean of disposable income and leisure. This is seen to modify the evaluation of changes in important ways. The results are found to differ from those obtained using a ‘welfarist’ evaluation in terms of money metric utility, where separate labour supply effects cannot be isolated.     

Joint Taxation and the Labour Supply of Married Women: Evidence from the Canadian Tax Reform of 1988*

The Canadian federal tax reform of 1988 replaced a spousal tax exemption with a non‐refundable tax credit. This reduced the‘jointness’of the tax system: after the reform, secondary earners’effective‘first dollar’marginal tax rates no longer depended on the marginal tax rates of their spouses. In practice, the effective‘first dollar’marginal tax rates faced by women with high‐income husbands were particularly reduced. Using difference‐indifference estimators, we find a significant increase in labour force participation among women married to higher‐income husbands.     

MEASURING CORPORATE TAX RATES AND TAX INCENTIVES: A NEW APPROACH

Taxes play an important but underemphasized role in the valuation of a company and its projects. For example, the authors estimate that the expected tax benefits from interest deductions by all publicly traded U.S. corporations were responsible for almost $1.4 trillion of their total market value of $12.7 trillion in 1991. In the case of RJR's 1989 leveraged buyout alone, the capitalized value of the interest tax shield amounted to several billion dollars (or about 25%) of the company's market value.
This article argues that, to maximize shareholder wealth, the corporate planning process should include a careful analysis of corporate tax incentives. Using several examples, the authors show how earnings variability and major provisions of the tax code interact to affect a company's expected marginal tax rate. After describing the complexities involved in properly calculating corporate tax rates, the article concludes by describing a simulation method the authors have developed to measure a company's effective marginal tax rate and, hence, its tax incentives to use more leverage (or some other means of reducing taxable income).
In furnishing a method for calculating marginal tax rates with greater accuracy, the authors also provide a clue to resolving the capital structure puzzle discussed in the roundtable at the head of this issue. In particular, their recent research corrects earlier studies in the finance literature by showing that when marginal tax rates are measured before financing (that is, based on income before interest expense is deducted), there is a positive relation between debt usage and tax rates.     

Why Are Mothers Working Longer Hours in Austria than in Germany? A Comparative Microsimulation Analysis*

Labour force participation rates of mothers in Austria and Germany are similar; however, full‐time employment rates are much higher among Austrian mothers. In order to find out to what extent these differences can be attributed to differences in the tax‐transfer system, we perform a comparative microsimulation exercise. After estimating structural labour supply models for both countries, we interchange two important institutional characteristics of the two countries ‐ namely, (i) the definition of the tax unit within the personal income tax and (ii) the parental leave benefit scheme. As our analysis shows, differences in mothers’employment patterns can partly be explained by the different tax systems: while Germany has a system of joint taxation with income splitting for married couples, Austria taxes everyone individually, which leads to lower marginal tax rates for secondary earners than in the German system.     

Pollution, Factor Taxation and Unemployment

When consumers choose between clean and dirty goods and the labour market clears, a green tax reform may not bring about a double dividend in the sense of increasing environmental quality and increasing employment. However, when firms choose between clean and dirty factors of production, and when there is unemployment, such a result is very likely to occur. The paper investigates a model of a monopolistic firm where labour and energy are factors of production and trade unions negotiate the wage rate, accepting some unemployment as a result of aggressive wage demands. It is shown that, in such a framework, a green tax reform will boost employment provided it does not increase the net-of-tax wage rate by too much. This is the case when the elasticity of substitution between labour and energy is greater than one, equal to one or not too far below one.     

Indirect tax reform and the role of exemptions

This paper examines the question of whether indirect tax rates should be uniform, using four different modelling strategies. First, marginal tax reform is examined. This is concerned with the optimal direction of small changes in effective indirect tax rates and requires considerably less information than the calculation of optimal rates. Second, the welfare effects of a partial shift from the current indirect tax system in Australia towards a goods and services tax (GST) are considered, with particular emphasis on differences between household types and the role of exemptions. Third, in view of the stress on a distributional role for exemptions of certain goods from a GST, the potential limits to such redistribution are considered. The fourth approach examines the extent of horizontal inequity and reranking that can arise when there are non‐uniform tax rates. These inequities arise essentially because of preference heterogeneity.     

Macroeconomic implications for tax indexing in the McCallum-Whitaker framework

A macroeconomic model that incorporates rational expectations and the natural-rate hypothesis is used to establish the propositions: When supply and demand shocks are not negatively correlated, then (a) at the same marginal tax rate, a nominal tax structure dominates an indexed tax structure when the policy criterion is minimization of variance of the expectational error of the price level, and (b) an indexed tax structure can dominate a nominal tax structure when minimization of output variance is the policy goal, but may require a higher marginal tax rate. These propositions are independent of the elasticity of aggregate demand, or equivalently, the McCallum-Whitaker stability condition.     

Indirect tax harmonization and global public goods

This paper identifies conditions under which, starting from any tax-distorting equilibrium, destination- and origin-based indirect tax-harmonizing reforms are potentially Pareto improving in the presence of global public goods. The first condition (unrequited transfers between governments) requires that transfers are designed in such a way that the marginal valuations of the global public goods are equalized, whereas the second (conditional revenue changes) requires that the change in global tax revenues, as a consequence of tax harmonization, is consistent with the under/over-provision of global public goods relative to the (modified) Samuelson rule. Under these conditions, tax harmonization results in redistributing the gains from a reduction in global deadweight loss and any changes in global tax revenues according to the Pareto principle. And this is the case independently of the tax principle in place (destination or origin).