Optimal Dynamic Taxation with Distinctive Forms of Social Status Attainment

We examine the role of both consumption‐ and wealth‐induced social comparisons in setting dynamic optimal income taxation. Under complete information, state‐invariant labor income taxes are used to remedy the externality caused by consumption‐induced social comparisons, while state‐contingent capital income taxes are used to remedy the externalities caused by both consumption‐ and wealth‐induced social comparisons. Under incomplete information, distinct types of agents are subject to an identical marginal capital income tax, which removes social comparisons. To solve the information problem, low‐productivity agents could be subject to a lower marginal labor tax than high‐productivity agents, which contradicts the traditional result in the Mirrlees–Stiglitz models.     

Optimal income tax under the threat of migration by top-income earners

We examine how allowing individuals to emigrate to pay lower taxes changes the optimal nonlinear income tax scheme in a Mirrleesian economy. An individual emigrates if his domestic utility is less than his utility abroad, net of migration costs — utilities and costs both depending on productivity. A simple formula, that complements Saez's formula obtained in closed economy, is derived for the marginal tax rates faced by top-income earners. It depends on the labour elasticity, the tax rate abroad and the migration costs expressed as a fraction of the utility obtained abroad. The Rawlsian marginal tax rates, obtained for the whole population, illustrate a curse of the middle-skilled. Simulations are provided for the French economy.     

The Laffer curve in schedular multi-rate income taxes with non-genuine allowances: An application to Spain

This paper models the connection between tax revenue and marginal tax rates in modern personal income taxes. In so doing, new analytical expressions for the elasticity of tax revenue to tax rates are derived taking into account global and schedular income taxes in the presence of non-standard allowances. Based on these new analytical elasticities the implicit Laffer curve is characterised and explored in detail. Calculations are performed for the individual taxpayer and the aggregate population. When applied to microdata, the model permits us to locate individually the position of every taxpayer on the entire range of the Laffer curve as well as to characterise the “representative” aggregate Laffer curve. The utility of the model to forecast revenue is illustrated by applying it to Spanish personal income tax. The model confirms that the Laffer curve is essentially an intrinsic individual matter although a virtual aggregate Laffer curve for the whole population can be inferred.     

Externalities and optimal taxation

This paper reexamines the optimal tax design problem (income and commodities) in the presence of externalities. The nature of the second–best, and the choice of the tax instruments, are motivated by the informational structure in the economy. The main results are: (i) environmental levies (linear or nonlinear) differ in formula from Pigouvian taxes by the expressions for the optimal tax on private goods; (ii) externalities do not affect commodity tax formulas (linear and nonlinear) for private goods; (iii) externalities do not affect the income tax structure if commodity taxes are nonlinear and affect it if commodity taxes are linear; and (iv) a general income tax plus strictly Pigouvian taxes are sufficient for efficient taxation if individuals of different types have identical marginal rates of substitution (at any given consumption bundle).     

RELATIVITY,INEQUALITY, AND OPTIMAL NONLINEAR INCOME TAXATION

How does concern for consumption relative to others (“relativity”) affect the structure of optimal nonlinear income taxation? Our article provides three sets of answers to this general question. First, it supports the conclusion in the literature that relativity leads to higher marginal tax rates. In doing so, it both generalizes some of the conditions under which this result is obtained in the literature and fleshes out the detailed structure for optimal marginal tax rates for specific functional forms for distribution, utility function, and social welfare function. Second, the article goes beyond the literature and examines the impact of relativity on the progression of optimal marginal tax rates. By and large, we find support for greater progressivity, defined as the steepness of the rise of the marginal tax rate schedule, as relativity concern increases. Third, none of the papers in the literature, to our knowledge, examines the interplay of relativity and inequality in determining the optimal structure of income taxes. Our special analytical cases and more general numerical calculations support the conclusion that higher inequality dampens the positive impact of greater relativity on the level and the progression of marginal tax rates. More work is needed to further explore this interaction between relativity and inequality that our analysis has uncovered.     

The Collective Household, Household Production and Efficiency of Marginal Reforms

Most research on the welfare properties of taxes employs the unitary model of the household, ignoring household production. A simple model provides expressions for the changes in individual utility given marginal reforms to government policy. It is shown that the burden of a higher tax on household goods falls on the household member that consumes more than they produce or purchase. Numerical calculations show that price substitution (complementarity) between home and market labor increases (decreases) aggregate efficiency costs of a marginal redistribution of income without impacting the intra-household distribution of utility changes. Modeling household goods as public versus private can alter the distributional consequences of marginal reforms.     

Effect of the Tax System ON R&D Intensity,Growth, Wages and Consumption Share

We propose a general equilibrium knowledge‐driven (semi‐)endogenous‐growth model with horizontal R&D, which is extended to consider two types of labour, skilled and unskilled, and exogenous government expenditure, financed through taxes on financial assets and on labour income, to analyse the implications of the tax system on R&D intensity, economic growth, wage inequality and consumption share in the output. In particular, we show that: (i) taxes have negative influence in the consumption share, being higher the marginal effect of the labour‐income tax; (ii) for any given government expenditure share, an increase (a decrease) in financial‐assets tax decreases (increases) the labour‐income tax; (iii) only the financial‐assets tax affects negatively the R&D intensity and the skill‐premium; thus, to reduce the skill‐premium the financial‐assets tax must increase; (iv) ignoring the effect on wage inequality and on R&D intensity, taxes are substitutes.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

On the marginal excess burden of taxation in an overlapping generations model

We extend marginal excess burden (MEB) analysis in public finance literature to a dynamic general equilibrium model with incomplete markets and heterogeneous households. This extension allows us to quantitatively assess efficiency ranking and incidence of taxes. Our results indicate a disparity in welfare cost and distributional consequence of different forms of taxation on capital, labor and consumption. According to our MEB ranking, capital income taxation appears to be least efficient as it results in larger marginal excess burdens, compared to labor income tax and consumption tax. The tax incidence analysis shows variation of tax burdens across households, depending on their age, income type and generation. In particular, older households with higher income bear the highest burden of company income tax; meanwhile, future born households bear the highest burden of personal income tax. Hence, our MEB analysis demonstrates a fruitful approach to better understanding efficiency and incidence of tax reforms in one unified framework.     

Optimal Taxation when Consumers Have Endogenous Benchmark Levels of Consumption

I examine optimal taxes in an overlapping generations economy in which each consumer's utility depends on consumption relative to a weighted average of consumption by others (the benchmark level of consumption) as well as on the level of the consumer's own consumption. The socially optimal balanced growth path is characterized by the Modified Golden Rule and by a condition on the intergenerational allocation of consumption in each period. A competitive economy can be induced to attain the social optimum by a lump-sum pay-as-you-go social security system and a tax on capital income.     

Trade,environment, and income inequality: An optimal taxation approach

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor), and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under‐ or over‐internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade‐off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income toward the unskilled results paradoxically in less pollution and more income inequalities.     

Revenue-maximizing tax rates in personal income taxation in the presence of consumption taxes: a note

This article computes revenue-maximizing tax rates in personal income taxes in the presence of consumption taxes. It finds that the traditional Laffer analysis, which neglects the effects of marginal tax rates on consumption, overestimates the magnitude of revenue-maximizing tax rates. The bias caused by this oversight is computed.     

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.     

INCOME TAXES AND THE COMPOSITION OF PAY: EVIDENCE FROM THE BRITISH HOUSEHOLD PANEL SURVEY

According to the standard principal‐agent model, the optimal composition of pay should balance the provision of incentives with the individual demand for insurance. Do income taxes alter this balance? We show that the relative share of Performance‐related pay (PRP), on total pay is reduced by higher average and marginal income taxes. Empirical evidence based on the British Household Panel Survey is consistent with the theoretical predictions of the tax–augmented principal‐agent model. Our estimates suggest that a 10% reduction in the marginal income tax rate, holding the average tax rate constant, increases the share of PRP in total pay by 2.25–3.02%, depending on the empirical specification. Similarly, a 10% reduction in the average income tax rate, holding the marginal tax rate constant, increases the share of PRP in total pay by 5.10–5.27%.     

Correcting Market Failure Due to Interdependent Preferences: When Is Piecemeal Policy Possible?

Allowing for general utility interdependence and agent heterogeneity, we characterize taxes that will generate first best solutions in markets. We show the equivalence of tax corrections derived from the Marshallian and compensated demand approaches. Next we analyze the conditions that are required for the market failure to be corrected by: (1) specific indirect ad valorem taxes on commodities, (2) the same proportional tax rate on every commodity, and (3) a proportional income tax rate on each individual. The conditions are related to the restrictions necessary to have H synthetic consumers without externalities who replicate behavior of individuals with externalities.     

The Optimal Linear Income Tax Model: Utility or Equivalent Income?

This paper compares the use of equivalent income with that of utility, in the social welfare function, in optimal income tax models. Equivalent income is a money metric welfare measure that, unlike utility, is not affected by monotonic transformations of utility. The use of equivalent income is found to produce an optimal tax rate that is more sensitive to the degree of inequality aversion, compared with the use of utility. With Cobb-Douglas and CES utility functions, the optimal tax rate is the same for utility and equivalent income where relative inequality aversion is unity. When using equivalent incomes, the case for high marginal rates does not depend on the assumption of a very low elasticity of substitution between consumption and leisure.     

The impact of taxes and wasteful government spending on giving

We examine how taxes impact charitable giving and how this relationship is affected by the degree of wasteful government spending. In our model, individuals make donations to charities knowing that the government collects a flat-rate tax on income (net of charitable donations) and redistributes part of the tax revenue. The rest of the tax revenue is wasted. The model predicts that a higher tax rate increases charitable donations. Surprisingly, the model shows that a higher degree of waste decreases donations (when the elasticity of marginal utility with respect to consumption is high enough). We test the model’s predictions using a laboratory experiment with actual donations to charities and find that the tax rate has an insignificant effect on giving. The degree of waste, however, has a large, negative and highly significant effect on giving.

     

Higher Tax for Top Earners

The literature can justify both increasing and decreasing marginal taxes (IMT & DMT) on top incomes under different welfare objectives and income distributions. Even when DMT are theoretically optimal, they are often politically infeasible. Then a flat tax seems to be a constrained optimal solution. We show however that, given any flat tax we can increase the total utility of a poor majority by raising the top income tax rate under a simple condition, which can be checked with empirical data. We further generalize our main results allowing different welfare weights, declining elasticity of labor supply and more tax bands.     

Old‐age Social Security versus Forward Intergenerational Public Goods Provision

This paper introduces an overlapping‐generations model with earnings heterogeneity and borrowing constraints. The labour income tax and the allocation of tax revenue between social security and forward intergenerational public goods are determined in a bidimensional majoritarian voting game played by successive generations. The political equilibrium is characterized by an ends‐against‐the‐middle equilibrium where low‐income and high‐income individuals form a coalition in favour of a lower tax rate and less social security while middle‐income individuals favour a higher tax rate and greater social security. Government spending then shifts from social security to public goods provision if higher wage inequality is associated with a borrowing constraint and a high elasticity of marginal utility of youth consumption.