Optimal income taxation when couples have endogenous bargaining power

This study examines the optimal income taxation for a two-earner household, where the couple bargains over their private goods consumption and time allocation between work and leisure. In the model, bargaining power is determined endogenously by the income gap between the two earners. Conventional studies have shown that the higher income tax rate should be imposed on the individual with the smaller wage elasticity, typically the individual with the higher productivity. In contrast to conventional argument, this study shows that the optimal tax rate on the household member with the higher productivity is lower than that of the individual with the lower productivity if the required tax revenue is relatively small and the influence of the gender income gap on the power balance of the couple is moderate. This is because such a tax structure encourages the labor supply of the individual with the higher productivity to mitigate the decrease in the household’s consumption induced by income taxation.     

A Case Against Zero Capital-Income Taxation

This paper develops a dynamic general equilibrium model to investigate the optimal level of capital income taxation in light of stochastic endogenous economic growth. Although endogenous human capital is incorporated into our model, we restrict our investigation to the issue of optimal physical capital income tax; and the labor supply is also endogenously determined. This paper proves that the optimal capital income tax should be zero provided exogenous government expenditure on production; however, capital income should be taxed if we consider endogenous government consumption.     

Optimal tax theory: A synthesis

Necessary conditions for optimal taxation are derived (i) when taxes are constrained to be linear, (ii) when the form of taxation is unconstrained, (iii) when some commodities are subject to nonlinear taxation, the remainder to proportional taxation. Among the results obtained are several that help to determine upon which commodities the tax system ought to bear most heavily. In particular, a criterion for the effect of commodity taxes in the presence of an optimal income tax is found. The paper concludes with a general principle of simple form for optimal economic policies of all kinds.     

A note on optimal income taxation,public goods provision and robust mechanism design

This paper extends the model of optimal income taxation due to Mirrlees (Mirrlees, J., 1971. An exploration in the theory of optimum income taxation. Review of Economic Studies 38, 175–208) and includes private information on public goods preferences. A mechanism design approach is used to establish the following result: If policies are required to be robustly implementable in the sense of Bergemann and Morris (Bergemann, D., Morris, S., 2005. Robust mechanism design. Econometrica 73, 1771–1813), then the optimality conditions in the extended model with uncertainty about tax and expenditure policies are the same as in the standard model of optimal income taxation. The paper provides a foundation for a widely-used assumption in public finance, namely that individuals optimize their behavior subject to a predetermined and commonly known tax system.     

On the undesirability of commodity taxation even when income taxation is not optimal

An important result due to Atkinson and Stiglitz (1976) [Atkinson, A.B., Stiglitz, J.E., 1976. The design of tax structure: Direct versus indirect taxation. Journal of Public Economics 6, 55–75.] is that differential commodity taxation is not optimal in the presence of an optimal nonlinear income tax (given weak separability of utility between labor and all consumption goods). This article demonstrates that this conclusion holds regardless of whether the income tax is optimal. In particular, given any commodity tax and income tax system, differential commodity taxation can be eliminated in a manner that results in a Pareto improvement. Also, differential commodity taxation can be proportionally reduced so as to generate a Pareto improvement. In addition, for commodity tax reforms that neither eliminate nor proportionally reduce differential taxation, a simple efficiency condition is offered for determining whether a Pareto improvement is possible.     

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.     

Optimal Capital Income Taxation with Means‐tested Benefits

This paper studies the interaction between capital income taxation and a means‐tested age pension. Our results document that the existence of a social insurance program financed from general revenue puts an upward pressure on the optimal tax rate. We also show that there is a negative relation between taper (benefit‐reduction) and optimal capital income tax rates. The potential welfare gain from optimizing capital taxation in the presence of a universal retirement transfer system is relatively higher. However, when the transfer is substantially means tested, the gain is lower, because the means test effectively operates as a tax on retirement capital.     

Investment behavior and the biased perception of limited loss deduction in income taxation

We use a laboratory experiment to study the extent to which investors’ choices are affected by limited loss deduction in income taxation. We first compare investment behavior in the no tax baseline to a tax control setting, in which the income from investments is taxed. We find that investors significantly reduce their risk-taking as predicted by theory. Next we compare the baseline investment choices to choices under three different types of income taxation. We observe that risk-taking is significantly increased with partial and with capped loss deduction, but is unaffected by a tax system that allows no loss deduction. Since in all these treatments the after tax outcomes of the prospects were identical, we conjecture that investors have a positively biased perception of partial and capped loss deduction that promotes their willingness to take risks.     

Migration and optimal income taxes

The issue addressed in this paper is the optimal taxation of incomes earned in the home economy, and of incomes earned abroad, when people can migrate. As a preliminary, the optimal taxation of home incomes when there is migration and no taxation of foreign incomes, is discussed. Then in a more general setting, we deal with optimal taxation of different kinds of labour when another kind of labour is not taxable, and show how this bears on the taxation of foreign incomes. The last sections of the paper analyse a simple model in which people choose between taxable labour at home, taxable labour abroad, and untaxable labour. A condition is found implying that the optimal tax on foreign income is higher than on the home income of a person of equal utility.     

Environmental tax policy in a model of growth cycles

Summary. The purpose of this paper is to consider environmental taxation which would control emissions of firms in a model of growth cycles. In the model presented below, the economy may experience two phases of growth and environmental quality: “the no-innovation growth regime” and “the innovation-led growth regime”. Aggregate capital and environmental quality remain constant in the no-innovation growth regime, while they perpetually increase in the innovation-led growth regime. The paper shows that the tax plays a key role in determining whether the economy stably converges to one of the two regimes or fluctuates permanently between them. It also shows that there is a critical level of the tax and that the economy obtains higher growth rates of capital and environmental quality by raising (or reducing) the tax if the initial tax is below (or above) the critical level. Received: April 2, 2001; revised version: March 21, 2002 RID="*" ID="*" This research reported here was conducted within the research project “Project on Intergenerational Equity” at Institute of Economic Research, Hitotsubashi University. I am deeply grateful to an anonymous referee for his or her insightful comments, which greatly improved the paper. I also thank Hiroshi Honda, Yasuo Maeda, Yuji Nakayama, and participants in workshops at Hitotsubashi University, Kyoto University, Nagoya University, Osaka University, University of Tsukuba, Yokohama National University, and University of Tokyo for their valuable comments and suggestions. Any remaining errors are mine.     

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.     

On the Popular Support for Progressive Taxation

The “popular support for progressive taxation theorem” ( Marhuenda and Ortuño‐Ortín, 1995 ) provides an important formalization of the intuition that a majority of relatively poor voters over rich ones leads to progressive income taxation. Yet the theorem does not provide an equilibrium outcome. In addition, it assumes an overly restrictive domain of tax schedules and no incentive effects of income taxation. This paper shows that none of these assumptions of the theorem can be relaxed completely. Most notably, it is shown that a majority of poor voters does not imply progressive taxation in a more general policy space and that a regressive tax schedule may obtain a majority over a progressive one when individuals' income is endogenous.     

Redistributive taxation as social insurance

The modern literature on nonlinear optimal taxation treats differences in income as being due to unobserved differences in ability. A striking result of this assumption is that high income agents should face a zero marginal tax rate. In this paper I assume that differences in observed income are due to exogenous differences in luck. Hence the optimal redistributive tax involves trading off the benefits due to ‘social insurance’ with the costs due to reduced incentives. I derive the optimal forms for linear and nonlinear taxes, and compute some algebraic and numeric examples. Typically high income individuals will face quite high marginal tax rates.     

The efficient side of progressive income taxation

This paper examines allocative properties of progressive income taxation when individuals care about their relative income. It shows that introducing a progressive income tax can yield a Pareto improvement if pre-tax income is evenly distributed. Implementing undistorted choices of working hours requires a progressive tax schedule, and the optimal degree of progressivity decreases with pre-tax income inequality.     

Growth and Welfare Effects of Tax Cuts: The Case of a Productive Public Input with Technological Risk

This paper analyzes the dynamic impact of tax cuts within a stochastic model of endogenous growth with a congested public input. A decreasing taxation of deterministic income parts leads to the well-known positive growth effect. Nevertheless, due to the insurance effect associated with the taxation of stochastic income flows, the overall growth impact of taxation is ambiguous. It is shown that the optimal structure of financing government expenditure does not only depend on the degree of rivalry but also on the degree of risk aversion. The optimal real value of government debt decreases with a rise in congestion. We identify that in the case of proportional congestion, the base for tax cuts should be the growth neutral consumption tax. Maximizing the growth rate does not automatically coincide with maximizing welfare. Hence, the base for tax cuts gains importance to realize a welfare optimal policy.     

Using Elasticities to Derive Optimal Income Tax Rates

This paper derives optimal income tax formulas using compensated and uncompensated elasticities of earnings with respect to tax rates. A simple formula for the high income optimal tax rate is obtained as a function of these elasticities and the thickness of the top tail of the income distribution. In the general non-linear income tax problem, this method using elasticities shows precisely how the different economic effects come into play and which are the key relevant parameters in the optimal income tax formulas of Mirrlees. The optimal non-linear tax rate formulas are expressed in terms of elasticities and the shape of the income distribution. These formulas are implemented numerically using empirical earning distributions and a range of realistic elasticity parameters.     

Optimal Indirect and Capital Taxation

We consider an environment in which agents' skills are private information and follow arbitrary stochastic processes. We prove that it is typically Pareto optimal for an individual's marginal benefit of investing in capital to exceed his marginal cost of doing so. This wedge is consistent with a positive tax on capital income. We also prove that it is Pareto optimal for the marginal rate of substitution between any two consumption goods to equal the marginal rate of transformation. This lack of a wedge is consistent with uniform taxation of consumption goods within a period.     

Time-consistent taxation in a dynastic family model with human and physical capital and a balanced government budget

Abstract .  This paper analyzes optimal, time consistent taxation in a dynastic family model with human and physical capital and with a balanced government budget. When tax revenue is used for publicly provided consumption or lump-sum transfers, leisure would be higher than its social optimum. Pareto optimal taxation requires taxing capital income more heavily than labour income and subsidizing investment at the same rate of the tax. Also, it requires either subsidizing labour at the same rate as a consumption tax or subsidizing consumption at the same rate as a labour income tax, and hence it is not a practical guide to policy. Further, a consumption tax, or equivalently a uniform income tax with investment subsidies at the same rate, can be improved on by taxing capital income more heavily than labour income.