Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation

This paper studies optimal capital and labor income taxes when the benefits of public goods are age‐dependent. Provided the government can impose a consumption tax, it can attain the first‐best resource allocation. This involves the uniform taxation of the cohorts' labor income and a zero capital income tax. With no consumption tax and optimally chosen government spending, labor income should be taxed nonuniformly across cohorts and the capital income tax should be nonzero. Deviations of the public goods from their respective optima create distortions. These affect the labor supply decisions of both cohorts and capital accumulation, providing a further reason to tax (or subsidize) capital income.     

Discreteness and the Welfare Cost of Labor Supply Tax Distortions*

We compare the welfare costs of tax distortions of labor supply in one‐ and two‐member household discrete and continuous choice labor supply (leisure consumption) models calibrated to the same aggregate uncompensated labor supply elasticities. In the discrete models, taxes induce a large response from a subset of the population, whereas the majority of the population exhibits unchanged behavior. In contrast, the majority of the population reacts to tax changes in continuous models. Discrete choice matters as the welfare costs of similar taxes vary significantly when individuals face discrete labor supply choices from when they choose working hours continuously.     

Costs of Taxation and Benefits of Public Goods with Multiple Taxes and Goods

The fact that raising taxes can increase taxed labor supply through income effects is frequently and erroneously used to justify greater public good provision than indicated by traditional, compensated analyses. We develop a model including multiple public goods and taxes and derive measures of the marginal benefits of public goods and the Marginal Cost of Funds (MCF) using both compensated and uncompensated measures. We confirm that the desirability of tax‐financed public projects is independent of the method used. An important innovation is to show that the benefits of public goods must be adjusted by a benefit multiplier not previously seen in the literature if an uncompensated MCF is used.     

Optimal Differentiation of International Environmental Taxes in the Presence of National Labor Market Distortions

We explore the implication of the `doubledividend' debate for international environmentaltaxes. In our scenario, small open economies withdifferent labor market distortions follow a commonenvironmental policy and use national environmentaltax revenues to finance labor tax cuts. Since thedouble dividend hypothesis does not hold, a high labortax implies a low environmental tax relative to othercountries. The optimal differentiation ofinternational environmental taxes is proven to be afunction of the national labor tax rates and theuncompensated elasticities of labor supply.     

Scale-dependent and risky returns to savings: Consequences for optimal capital taxation

I present a model of optimal capital taxation where agents with heterogeneous labor productivity randomly draw their rate of return to savings. Because of scale dependence, the distribution of rates of returns can depend on the amount saved. Uncertainty in returns to savings yields an insurance rationale for taxing capital on top of labor income. I first show that, because of scale dependence, agents making the same saving decision should access the same rate of return at the optimum. I then constrain the information set of the government and show that, as soon as return are uncertain, positive capital income taxation is needed at the optimum. The optimal linear tax on capital income trades off insurance with distortions to both savings and to the rate of return in a context of scale dependence. Eventually, I argue that scale dependence in and of itself is not sufficient to justify capital taxation on top of labor income taxes. These results are still valid when agents can optimize between a risk-free and a risky-asset that can both exhibit scale dependence.     

Tax collection,the informal sector,and productivity

An important determinant of informality in a country is its tax enforcement capacity, which some authors argue further distorts the decisions of firms and creates inefficiency. In this paper, I assess the quantitative effect of incomplete tax enforcement on aggregate output and productivity using a dynamic general equilibrium framework. I calibrate the model using data for Mexico, where the informal sector is large. I then investigate the effects of improving enforcement. I find that under complete enforcement, Mexico's labor productivity and output would be 19% higher under perfect competition and 34% higher under monopolistic competition. The source of this gain is the removal of the distortions induced by incomplete enforcement of taxes. These distortions affect the economy in three ways: by reducing the capital–labor ratios of informal establishments; by allowing low-productive entrepreneurs to enter; and by misallocating resources towards low-productive establishments. As a result, TFP and capital accumulation are reduced, and hence output. I decompose the gains following the guidelines of five leading papers in the literature of resource misallocation across plants. I isolate the effects of pure factor misallocation, distorted occupational choices, capital accumulation, and complementarities. I also study marginal improvements in enforcement and find that there is an inverted-U relationship between the size of the informal sector and output. This reflects the fact that improving enforcement entails a tradeoff: more taxes vs. fewer distortions.     

A second-best evaluation of eight policy instruments to reduce carbon emissions

This paper uses a numerical general equilibrium model to compare the costs of alternative policies for reducing carbon emissions in a second-best setting with a distortionary tax on labor. We examine a carbon tax, two energy taxes, and both narrow-based and broad-based emissions permits and performance standards. The presence of pre-existing tax distortions raises the costs of all these policies, and can affect their relative cost rankings. In fact, the superiority of emissions taxes and emissions permits over other instruments can hinge on whether these policies generate revenues that are used to reduce other distortionary taxes.     

Taxation, Bequests, and Short and Long Run Timber Supplies: An Overlapping Generations Problem

This paper uses an overlapping generations model with one-sided altruism to study the effects of several forest taxes that target bequests and affect timber supply. Unlike previous work, we investigate bequests and timber supply in both the short and long run when bequests are costly (e.g., taxed). The landowner's problem is examined in the short run, while the government's problem is examined in the long run assuming the existence of a steady state. We also consider taxes targeting harvests, growth, savings and bequests. Several new results are established concerning the interactions of taxes that might be used by a government to alter short and long run forest capital stocks: (i) the presence of a forest bequest tax affects the neutrality of harvest tax in both the short and long run, (ii) in the long run the bequest tax decreases bequests and timber supplies. When the bequest tax is not present, the capital income tax is neutral with respect to bequest and timber supply, while the harvest tax is neutral only if forest productivity is also not taxed. Finally, (iii) in the short run, the substitution and total effects of taxes in landowner decisions generally depend on the presence of the bequest tax. The results have implications for Pigouvian tax design and second best tax choice.     

Which commodity taxes should supplement the income tax?

The analysis takes as its point of departure a continuum of consumers economy in which an optimum income tax exists and is the only tax instrument in operation. The welfare effects of introducing small excise taxes to supplement the income tax are then explored. Essential in this context are changes in the tax distortions of work incentives. It is shown that a commodity should be taxed or subsidized depending on whether it is positively or negatively related to leisure in a sense which is precisely defined. The results are related to earlier contributions to the literature on direct versus indirect taxation.     

Environmental taxes with heterogeneous consumers: an application to energy consumption in France

This paper constructs a model with four groups of households who have preferences over labor supply, consumption of polluting (energy related) and non-polluting (non-energy) goods, and emissions. It quantifies the model for the French economy and computes its optimal tax equilibria under nine second-best tax regimes. We find that the redistributive role of environmental taxes requires the polluting goods to be taxed at a rate much below their marginal social damage. These goods may even require an outright subsidy if the society values equality ‘a lot’. Secondly, if environmental taxes that have an exclusively externality-correcting role, they benefit all types—although the gains are rather modest. The gains and losses become more substantial when environmental taxes have a redistributive role as well. Third, setting the environmental tax at its Pigouvian level, rather than its optimal externality-correcting-cum-redistributive level, benefits the high-income group at the expense of the low-income groups. Fourth, nonlinear taxation of polluting goods, and nonlinear commodity taxation in general, is a powerful redistributive mechanism. Fifth, introducing environmental taxes in the current French tax system, with its suboptimal income taxes, results in substantial welfare gains for the highest income group and a sizable loss for the least well-off persons.     

The effects of joint taxation of married couples on labor supply and non-wage income

The United States changed its tax treatment of married couples in 1948, from a system in which each spouse paid taxes on his or her own income to a system in which a married couple is taxed as a unit. The switch from separate to joint taxation changed incentives for labor supply and asset ownership. This paper investigates the effects of the conversion to joint taxation, taking advantage of a natural experiment created by cross-state variation in property laws. Married individuals in states with community property laws had always been taxed as if each spouse had earned half of the couple's income, and thus were unaffected by the 1948 legal change. Comparing the behavior of highly-educated taxpayers in affected and unaffected states indicates that the tax change is associated with a decline of approximately 2 percentage points in the employment rate of married women, consistent with the higher first-dollar tax rates they faced after 1948. Women married to self-employed men were also less likely to have non-wage income after 1948, reflecting pre-1948 allocation of family assets to wives for tax purposes. The effects of joint taxation on married men's labor force participation and non-wage income holding are generally not statistically significant.     

Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two‐period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks and the degree of heterogeneity among consumers' income, as well as on the way in which the tax revenue is used to provide lump‐sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases a negative tax on capital is welfare‐improving.     

Optimal Taxation of Risky Human Capital*

In a two‐period life‐cycle model with ex ante homogeneous households, earnings risk, and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work. Education subsidies are not used for social insurance, but they are only targeted at offsetting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, because education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non‐tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education because of risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor‐market risk, optimal tax rates could be lower than in the case without education subsidies.     

Optimal human capital policies under the endogenous choice of educational types

This study examines optimal human capital policies under nonlinear labor and capital income taxes in the presence of consumption value of education in a two‐period setting. We show that when individuals can choose educational types differing by the relative importance of consumption value and production value, education subsidies for low‐type individuals should not equal an efficient level that offsets distortions induced by nonlinear taxes on labor and capital income. Our findings imply that education policy does not restore efficiency, or the Diamond–Mirrlees production efficiency theorem fails. Moreover, capital income taxation is optimal, which means that the Atkinson–Stiglitz theorem breaks down.     

Tax avoidance and intra-family transfers

We study how taxes on intra-family transfers (bequests and gifts) affect parents' transfers to their children. Our focus is on the incentives for tax avoidance. These issues are important for families and their welfare, as well as for governments and their possibilities of raising revenue from transfer taxes. Using a theoretical model, we show how altruistic parents avoid taxes by changing the timing of transfers when inter vivos gifts are taxed separately from bequests (which is the case in many developed countries). The excess burden per tax dollar of the transfer taxes is sometimes infinitely large because of tax avoidance. All tax avoidance is eliminated if bequests and gifts from the same donor are jointly taxed.     

Age-related taxation of bequests in the presence of a dependency risk

This paper studies the properties of the optimal taxes on bequests when individuals differ in wage and in their risks of mortality and old-age dependance. Survival is positively correlated to income but dependency is negatively correlated with it. The government cannot distinguish between bequests motives, that is whether bequests resulted from precautionary reasons or from pure joy of giving reasons. Instead, it observes the timing of bequests and the health status at death. Under the utilitarian social welfare criterion, we show that bequests taxation results from a combination of equity, insurance, and public revenue motives. If redistribution concerns dominate insurance concerns, it is desirable to tax the most bequests of those individuals living long in good health and to tax the least bequests of those dying early. This is a direct consequence of the socio-demographic structure we assumed where richer agents live longer and in better health than poorer agents. To the opposite, if insurance concerns dominate redistributive concerns, early bequests should be the most taxed and, bequests under dependency the least taxed. Under the Rawlsian criterion, we find that early bequests should be the least taxed and bequests left by the healthy long-lived individuals should be the most taxed.     

The double dividend, second-best worlds, and real-world environmental policy

The recent series of papers by Bovemberg, Goulder, Parry and others argue that the double dividend is unlikely to exist because of second-best problems. They argue that the imposition of environmental tax in an economy already distorted by income taxes will further distort the economy by reducing incentives to supply labor. Our paper argues that this is not likely to be the case because of the restrictive assumptions made by these models, and because of the role of the environment as a factor of production.     

Optimal taxation with consumption time as a leisure or labor substitute

This paper studies the optimal commodity taxation problem when time taken in consumption is a perfect substitute for either labor or leisure. It shows that while labor substitutability affects the optimal tax structure, leisure substitutability leaves the classical optimal tax results intact. In the Ramsey tax framework with linear income taxes, whether the consumers have the same or different earning abilities, labor substitutes tend to be taxed at a higher rate than leisure substitutes with the tax differential being increasing in consumption time. This is not necessarily the case when one allows for nonlinear income taxation.     

Revenue Recycling and the Welfare Effects of Road Pricing

This paper explores the interactions between taxes on work-related traffic congestion and pre-existing distortionary taxes in the labor market. A congestion tax raises the overall costs of commuting to work and discourages labor force participation. The resulting welfare loss in the labor market can easily exceed the Pigouvian welfare gain from internalizing the congestion externality. However, if congestion tax revenues are used to reduce labor taxes, the net impact on labor supply is positive, and this can raise the overall welfare gain from the congestion tax by around 100 percent. Nonetheless the optimal congestion tax still equals the Pigouvian tax.
JEL classification R 41; H 21; H 23