Optimal income transfers

A substantial literature addresses the design of transfer programs and policies, including the negative income tax, other means-tested transfers, the earned income tax credit, categorical assistance, and work inducements. This work is largely independent of that on the optimal nonlinear income tax, yet formulations of such a tax necessarily address how low-income individuals should be treated. This paper draws on the optimal income taxation literature to illuminate the analysis of transfer programs, including the level and shape of marginal tax rates (including phase-outs), the structure of categorical assistance, and the role of work inducements in an optimal income transfer scheme. JEL Classification H21 · H53 · I38     

Profit tax competition and formula apportionment

We analyze corporate income tax competition with international capital mobility when the common tax base is allocated to governments according to an apportionment formula. Labor can be either internationally mobile or immobile. We compare the Nash equilibria for different apportionment methods. Tax competition produces lower tax rates the more elastically the formula share responds to tax rate changes. More specifically, equilibrium tax rates are typically lowest when apportionment is based on property-shares, followed by payroll- and sales-shares apportionment. Compared to their cooperative levels, equilibrium tax rates are too low for property-share apportionment but tend to be too high for the other formulas. JEL Classification H77 · H25 · F23     

Labor-dependent capital income taxation

Capital taxation which is negatively correlated with labor supply is proposed. This paper uses a life-cycle model of heterogeneous agents that face idiosyncratic productivity shocks and shows that the tax scheme provides a strong work incentive when households possess large assets and high productivity later in the life-cycle, when they otherwise would work less. The system also adds to the saving motive of prime-age households and raises aggregate capital. The increased economic activities expand the tax base and the revenue neutral reform results in a lower average tax rate. The negative cross-dependence generates a sizable welfare gain in the long-run relative to the tax system that treats labor and capital income separately as a tax base. The reform, however, can hurt the elderly during the transition with a high marginal tax on their capital income.     

Corporate and personal income tax declarations

Decisions by firms and individuals on the extent of their tax payments have generally been treated as separate choices. Empirically, a positive relationship between corporate and personal income tax evasion can be observed. The theoretical analysis in this paper shows that a manager's decision on the firm's behaviour will be independent of his personal preferences if the gain from reducing corporate tax payments is certain, as in the case of tax avoidance. If, however, the firm evades taxes so that the manager's income depends on whether the firm's activities are detected or not, corporate and personal income tax evasion choices cannot be separated. Jel Code H 24 · H 25 · H 26     

Education policies and optimal taxation

This paper studies the design of education policies in a setting in which optimal redistributive labor taxation is available. It is usually argued that the crucial parameter to guide education policy is the complementarity of education and ability. This is true only when labor supply is fixed or when income taxes are not allowed. I show that, if labor supply is endogenous and if the government can tax income in a nonlinear way, the crucial parameter is how the education elasticity of wage changes with ability. Taking the elasticity criterion into account, education subsidies are optimal in cases in which, under the complementarity criterion, education taxes would be optimal. To do this, I use an asymmetric information setting that motivates nonlinear taxation of income and education. JEL Classification H21 · H23 · H52 · I28     

Taxpayers' responsiveness to tax rate changes and implications for the cost of taxation in Sweden

Historically, labor supply elasticities have been used to evaluate tax policy and predict tax revenue effects. They are likely to underestimate taxpayers' response to tax rate changes, and hence to underestimate changes in potential tax revenues, however, because they measure only how taxpayers alter hours worked. Taxpayers can also respond to tax rate changes by altering, for instance, their work effort and form of compensation. An alternative measure that accounts for these responses as well as hours worked is the elasticity of taxable income. This paper estimates the elasticity of earned taxable income for Swedish taxpayers using two different approaches and a number of control variables and the 1990/1991 tax reform as a “natural experiment”. The preferred elasticity estimates fall in the range of 0.4–0.5, comparable with recent estimates for the U.S. and larger than most of the labor supply elasticity estimates used to evaluate tax policy in Scandinavia previously, which suggests that deadweight losses are two to three times higher than previously thought. JEL Classification H21 · H24 · H31 · J22     

Migration and the welfare state: The economic power of the non-voter?

This paper investigates the impact of emigration on the political choice of the size of the welfare state. Mobility has two countervailing effects: the political participation effect and the tax base effect. With emigration, the composition of the constituency changes. This increases the political influence of the less mobile part of the population. But the new political majority then also has to take into account that emigration reduces tax revenues and thereby affects the feasible set of redistribution policies. We find that the direction of the total effect of migration depends on the initial income distribution in the economy. Our results also contribute to the empirical debate on the validity of the median-voter approach in cross-country studies for explaining the relation between income inequality and redistribution levels. JEL Classification F22 · H50 · D31 · D72     

Taxes and stabilization in contemporary macroeconomic models

The role of proportional and procyclic labor income taxes for automatic stabilization with stochastic productivity is analyzed in a contemporary macroeconomic model based on imperfect competition. The importance of short-run nominal wage rigidity for the effectiveness of progressive taxes on labor income for stabilizing output and raising household welfare is examined in a model that yields complete analytical solutions with stochastic output shocks. Increasing the procyclicity of labor income tax rates raises welfare with and without rigid nominal wages in the model economy. With fully flexible prices and wages, a positive covariance between the distortionary tax rate and productivity reduces the volatility of production and employment. This effect disappears under nominal wage rigidity, although progressive taxation can still raise welfare by reducing the distortion caused by a proportional labor tax. With rigid nominal wages and flexible consumer goods prices, payroll taxes levied at rates that rise with output can serve as automatic stabilizers. JEL Code E62 · H20     

National income taxation and the geographic distribution of population

We study how different national taxation schemes interact with geographic variation in productivity and consumption amenities in determining regional populations. A neoclassical migration equilibrium model is used to analyze the current nominal income tax system in Norway. The analysis is based on estimated regional income differences accounting for both observable and unobservable individual characteristics and the value of experience. Given regional differences in incomes and housing prices, quality of life and productivity are calibrated to model equilibrium. Compared to an undistorted equilibrium with lump-sum taxation, nominal income taxation creates a disincentive to locate in productive high-income regions. The deadweight loss due to locational inefficiencies is 0.18% of gross domestic product (GDP). We study real income taxation and equal real taxes as alternative tax systems. Both alternatives generate a geographic distribution of the population closer to the undistorted equilibrium, and hence with lower deadweight loss. In an extension of the analysis, we take into account payroll taxes. The existing regionally differentiated payroll taxes to the disadvantage of cities generate a deadweight loss of 0.22% of GDP in an economy with lump-sum income taxation. The two distortionary taxes interact and strengthen each other and the combined distortionary effect of income and payroll taxation in the Norwegian system is 0.46% of GDP.     

Optimal taxation and welfare benefits with monitoring of job search

In order to investigate the interaction between tax policy, welfare benefits, the government technology for monitoring and sanctioning inadequate search, workfare, and externalities from work, we incorporate endogenous job search and involuntary unemployment into a model of optimal nonlinear income taxation. In this setting, the government faces a trade-off between boosting employment of low-skilled agents and raising work effort of high-skilled workers. If sanctions for inadequate search effort can be targeted at high productivity types for whom it is socially optimal to search, the government can afford to levy higher labor taxes on marginal workers without discouraging these agents from seeking work. This allows for lower marginal taxes on work effort of agents with a job. In contrast to workfare, job externalities in the private sector raise marginal tax rates, as the government attaches more importance to boosting employment of low-skilled workers.     

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.     

An equitable,efficient and implementable scheme to control global carbon dioxide emissions

We design an international scheme to control global externalities in which autonomous regions choose their own emissions levels in anticipation of interregional resource transfers implemented by an international agency. This agency follows a proportional equity principle, which preserves the status-quo ratio of regional welfare levels. We show that it is individually rational for each region to participate in the proposed international scheme and that regional environmental authorities choose policies that fully internalize the global externality. Although based on an admittedly ideal scheme, these results are especially noteworthy in light of the call for various forms of transfers in international agreements such as the Kyoto Protocol. JEL Code: C72 · D62 · D78 · H41 · H77 · Q28     

The tax benefit of income smoothing

A worker can reduce tax liability by contributing to a private pension plan when marginal tax rates are high and withdraw pension benefits when marginal tax rates are low. We quantify the tax benefit of income smoothing through the private retirement system and find that it is negligible. This conclusion is important to households, investment advisers, tax policymakers, and scholars engaged in financial retirement planning.     

Voting on Pensions with Endogenous Retirement Age

It is often argued that the observed trend towards early retirement is due mainly to the implicit tax imposed on continued activity of elderly workers. We study the relevance of such a distortion in a political economy model with endogenous age of retirement. The setting is a two-period overlapping generations model. Individuals differ in their productivity. In the first period they work a fixed amount of time; in the second, they choose when to retire and then receive a flat rate pension benefit. Pensions are financed by a payroll tax on earnings in the first and in the second period of life. Such a tax is non distortionary in the first period; it is distortionary in the second period. We allow for some rebating of the second period tax. Individuals vote on the level of the payroll tax given the rebate which can range from 0 (biased system) to 100% (neutral system). We provide sufficient conditions for the existence of a voting equilibrium and study its properties. Under these conditions, high tax rates are supported by all the old and by low productivity young individuals. We show that the pivotal voter is a young individual. The number of young individuals who have higher wage than the pivotal voter equals half the total population. We also show that the introduction of a bias increases the political support for the pension system. Finally, we study the simultaneous determination of the bias and the tax rate through a voting procedure and show that the equilibrium (if any) implies a bias which is always positive and may or not be larger than one.     

Dynamic fiscal policies and unemployment in a simple endogenous growth model

This paper analyzes the growth and employment effects of dynamic fiscal policies in an overlapping generations model with endogenous growth and imperfect labour markets. With balanced-budget policies, the modelled closed economy grows at a constant rate which is higher, the lower are the labour tax rate and the unemployment rate. Constant-flow budget policies are not feasible, while government Ponzi games are feasible only if economic agents have implausibly high savings rates. Furthermore, while constant-stock fiscal policies are sustainable, an increase in the debt-to-capital ratio is accompanied by higher taxes, a rise in unemployment and lower economic growth. JEL Classification E24 · J51 · H63 · O41     

A case for taxing education

In this paper we establish, contrary to conventional wisdom, a case for taxing education, as a supplement to the labor income tax, by drawing on some informational feature of education, which the government may utilize. Discretionary decisions of individuals to acquire education may serve as an additional signal (to earned labor income) on the underlying unobserved innate earning ability, thereby mitigating the informational constraint faced by the government. JEL Classification H2 · D6     

Slowing Fossil Fuel Extraction: A Role for Taxation of Exports,Capital Gains and Interest Income

This paper develops a model of a growing open economy rich in non‐renewable resources, the extraction of which negatively impacts domestic productivity and whose sector competes with final production for capital. We analyse how tax rates on capital gains and interest income and the time trend of an export revenue tax rate could slow the extraction of resources for export. We find that taxing capital gains and interest income at the same rate and setting an export revenue tax rate to decline at the marginal social cost of extraction would defer extraction. An export revenue tax rate need not fall over time to curb depletion if capital gains are taxed at a lower rate than interest income, which is second best to taxing asset returns at the same rate when the resources sector competes for capital.     

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.     

Do tax sparing agreements contribute to the attraction of FDI in developing countries?

Measuring the effects of taxation on FDI in developing countries requires consideration of the tax sparing provision. This provision signed between developed and developing countries protects host country fiscal incentives for FDI. This paper estimates the impact of tax sparing provisions on Japanese outbound FDI between 1989 and 2000. We find evidence that the tax sparing provision influences positively the location of Japanese FDI, even after having taken into account reversal causality. JEL Classification F23 · H25 · H32 We Thank Michael Devereux, Edward Graham, Robert Lipsey, David Margolis, Claudia Rivas, Deborah Swenson, anonymous referees and seminar participants at the Franco-Korean conference in Seoul, and at the Western Economic Association conference in Vancouver for helpful discussions.