Taxes,Risk Aversion,and the Size of the Underground Economy

Non‐parametric regression analysis was used to investigate the relationship between the effective tax rate and the relative size of the underground economy, using New Zealand data. The underlying theoretical framework is established, and it suggests an ambiguous prediction regarding the sign of the relationship we are studying. However, our non‐parametric empirical analysis, which also allows for the non‐stationarity of the time‐series data, produces a positive and ‘S‐shaped’ relationship, and this supports earlier empirical studies that imposed such functional forms. The estimated model is used to simulate the effects of hypothetical tax changes on the size of the New Zealand underground economy, and to draw policy conclusions.     

The experience of some OECD economies on tax smoothing

Observed random walk behaviour of a tax rate does not necessarily support the tax smoothing hypothesis though the latter implies the former. This article presents a direct test of tax smoothing by showing that if the tax smoothing hypothesis holds then the future tax rate should cointegrate with the current permanent government expenditure rate even though the tax rate is a random walk. This test is a direct and robust test of a number of ‘random walk models’ available in the literature. This procedure also enables us to differentiate among ‘strong tax smoothing’, ‘weak tax smoothing’ and ‘no-tax smoothing’, all of which are consistent with the random walk behaviour of a tax rate. Application of this test to Australia, Canada, Italy, Japan, the Netherlands, New Zealand, the UK and the US show evidence in support of weak forms of tax smoothing.     

The Canadian underground and measured economies: Granger causality results

Using new time-series data for the size of the Canadian underground economy, the relationship between unreported and measured GDP in that country is examined. Granger causality tests are conducted, with a proper allowance for the non-stationarity of the data. It is found that there is clear evidence of such causality from measured GDP to ‘hidden’ output, but only very mild evidence of Granger causality in the reverse direction. This result supports similar evidence for New Zealand reported by the first author, and has several interesting policy implications.     

Modelling the hidden economy and the tax-gap in New Zealand

This paper develops and estimates a structural, latent variable, model for the hidden economy in New Zealand, and a separate currency-demand model. The estimated latent variable model is used to generate an historical time-series index of hidden economic activity, which is calibrated via the information from the currency-demand model. Special attention is paid to data non-stationarity, and to diagnostic testing. Over the period 1968 to 1994, the size of the hidden economy is found to vary between 6.8% and 11.3% of measured GDP. This, in turn, implies that the total tax-gap is of the order of 6.4% to 10.2% of total tax liability in that country. Of course, not all of this foregone revenue would be recoverable, as not all of the activity in the underground economy is responsive to changes in taxation or other policies. First version received: August 1997/Final version received: March 1999     

Asymmetric Responses of the Underground Economy to Tax Changes: Evidence From New Zealand Data

This paper considers the relationship between taxes and the size of the New Zealand underground economy. Previous studies indicate that a positive relationship exists in this and certain other countries. This paper addresses the question: 'Is the response of the underground economy to an increase in taxes the same as its response to a decrease in taxes?' We find that although the effect on the underground economy of an upward movement in the effective tax rate is numerically greater than that of a downward tax movement, this difference is not statistically significant.     

Road tax interactions among local governments: a spatial panel data analysis of the French case over the period 1984–2000

This article contributes to the literature on local tax interactions. Its novelty lies in its focus on the interactions of local governments via an indirect local tax on vehicles such as the road tax sticker and its analysis of interactions between direct and indirect local taxation. The main purpose of this article is to provide an empirical analysis of the reaction of road tax policy in a given French ‘department’ to changes in road tax policy in other ‘departments’. The analysis uses a novel panel data set covering the 96 French metropolitan ‘departments’ for the period from 1984 to 2000. First, the results confirm the presence of significant spatial interactions between French ‘departments’ due to the road tax sticker. Second, the estimation results also show that the business tax rate and/or the property tax rate on developed land are complements to the road tax sticker, whereas the residence tax rate and/or the property tax rate on undeveloped land are substitutes to the road tax instrument. Finally, I find that ‘departments’ with a larger, younger and older population set higher rates for the road tax sticker. The results are robust regarding alternative weight matrices.     

THE FISCAL DIVIDEND MYTH OF AN INCOME/GST TAX SWITCH*

Reaping a windfall fiscal dividend from the taxation of the ‘underground’ economy's expenditures on ‘legitimate’ commodities is often seen as a significant advantage for a goods and services tax (GST) over an income tax. This claim ignores the changes in prices in the underground economy which would arise from the introduction of a GST. Employing a general equilibrium model which allows for tax evasion, we show that any ‘dividend’ arising from a change in the income tax/GST mix is equivalent to a rise in the income tax rate without a GST.     

On commodity tax harmonization and public goods provision

This paper argues that Pareto improvements based on harmonizing tax reforms expressed in terms of the divergence between actual and optimal tax structures and over/under provision of public goods require the use of ‘pseudo-optimal’ taxes instead of optimal ones. ‘Pseudo-optimal’ taxes are defined as those obtained using the optimal tax formulas but evaluated at any arbitrary initial tax structure. Within this context the paper reconfirms existing results showing that tax harmonization emerges as a strong policy instrument in achieving a potential Pareto-improvement.     

A decomposition of the Harberger expression for tax incidence

In this paper we propose a decomposition of the Harberger expression for the incidence of the corporate income tax into ‘commodity price distortion’ and ‘factor price distortion’ effects. By applying Harberger's estimates of the parameters for the U.S. economy, we will demonstrate that the factor price distortion effect, which has an extremely simple formal expression, explains 115 percent of the total effect of the tax change on the rate of return. This suggests that the commodity price distortion effect may be relatively unimportant in explaining the tax incidence. The difference between our two effects and Mieszkowski's (1967) output and factor substitution effects is also noted.     

Fiscal sustainability and dollarization: the case of Ecuador

This article tries to disentangle the dynamic relationships between fiscal variables and economic activity in a small emerging economy characterized by full dollarization, namely, Ecuador. We find that fiscal policy in Ecuador seems to be sustainable, explained by its policy of debt payment through oil revenues, rather than by a fiscal discipline that dollarization is supposed to encourage. The non-oil tax revenues variable is a purely adjusting variable. This result suggests that in a dollarized country that cannot benefit from the ‘seignorage’ revenues, the reliance on volatile oil revenues and on smoothing tax revenues leaves the economy’s fiscal sustainability vulnerable.     

Government policy to reduce pollution emissions within the overlapping generations model

This article develops an overlapping generations model with multiple categories of capital. The importance of this article is in its ability to analyse changes in the distribution of various categories of capital along the growth path of the economy. Economic growth is accompanied by capital growth as well as increase in pollution emissions. Implementing a government policy to reduce pollution emission would change the equilibrium path of capital distribution. Within the model, the government builds a corporate tax function that defines the tax rate as a function of a ‘desired’ pollution level. The tax rate decreases as the ‘desired’ pollution level is higher. When the ‘desired’ pollution level is higher than the actual pollution level, production is subsidized and pollution levels rise. An example and a simulation are presented in order to confirm the theoretical results and demonstrate that the model can be used for empirical analysis.     

Welfare effects of commodity tax harmonisation

The European Commission is currently seeking a rapid accelaration of the process of commodity tax harmonisation within the European Community. Substantial changes in domestic tax structures are envisaged, yet the welfare-theoretic basis of the policy has remained obscure. This note goes some way towards suggesting a welfare argument for harmonisation as a collective response to tax-induced trade distortions (intentional or otherwise). It is shown that a programme of multilateral domestic tax reform involving convergence towards an appropriately weighted average of pre-existing tax structures - a kind of ‘harmonisation’ - is potentially Pareto improving.     

Public good differentiation and the intensity of tax competition

We show that, in a setting where tax competition promotes efficiency, variation in the extent to which firms can use public goods to reduce costs brings about a reduction in the intensity of tax competition. This in turn brings about a loss of efficiency. In this environment, a ‘minimum tax’ counters the reduction in the intensity of tax competition, thereby enhancing efficiency. ‘Split-the-difference’ tax harmonization also potentially enhances efficiency but would not be agreed upon by governments because it lowers the payoff to at least one of them. This paper also presents an explanation for how traditionally high-tax countries have continued to set taxes at a relatively high rate even as markets have become more integrated.     

A general equilibrium analysis of property tax incidence

Mieszkowski's (1972) analysis of the ‘new view’ of property tax incidence dealt with a model of an economy containing only one sector and three factors, in which labor was immobile. Brueckner (1981) incorporated an equal utility condition into his general equilibrium analysis of property tax incidence to take worker mobility into account. His model, however, did not have capital as an input factor and the benefits of public expenditure were ignored. This paper extends previous research by using a general equilibrium model of an economy with two sectors, three factors, and multiple communities. Both capital and labor are assumed to be mobile and Brueckner's labor mobility condition is modified to include public expenditure effects. While the results of the analysis support the ‘new view’, they qualify the original Mieszkowski studies in many aspects. The model also sheds light on tax incidence in no-tax communities, which was often ignored in earlier studies.     

Indeterminacy, underground activities and tax evasion

This paper introduces underground activities and tax evasion into a one-sector dynamic general equilibrium model with aggregate external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is characterized by well behaved (downward sloping) labor demand schedules. This mechanism differs from the customary one, and it is complementary to it. Compared to traditional labor market income, the income derived from underground labor activity is subject to a lower expected tax rate when considering both the probability of detection and the evasion penalty. During a belief-driven expansion, the household allocates more time to both traditional and underground labor supply. In equilibrium, this action serves to lower the effective labor tax rate faced by the household, thus providing stimulus to aggregate labor supply so as to make the initial expansion self-fulfilling. The mechanism here is akin to a “regressive tax”; the household's effective tax rate depends negatively on the level of total labor income. We argue that an underground sector, and the associated tax evasion, offer a good economic rationale for a regressive tax rate.     

A note on the neutrality of the cash flow corporation tax

The cash flow tax has been widely recommended as a form of taxing corporate income which is neutral with respect to investment decisions. This note points out that the claim is valid only under the assumption that the tax rate is constant over time. By contrast, an ‘ideal’ profits tax is neutral whatever the time shape of the tax rate.     

On the possibility of an inverse relationship between tax rates and government revenues

When Arthur Laffer and other ‘supply side advocates’ plot total tax revenue as a function of a particular tax rate, they draw an upward-sloping segment called the normal range, followed by a downward-sloping segment called the prohibitive range. A brief literature review indicates that tax rates on the prohibitive range in theoretical and empirical models have been the result of particularly high tax rates, high elasticity parameters, or both. The labor tax rate which maximizes total revenue, for example, will depend on the assumed labor supply elasticity. This paper introduces a new curve which summarizes the tax rate and elasticity combinations that result in maximum revenues, separating the ‘normal area’ from the ‘prohibitive area’. A general- purpose empirical U.S. general equilibrium model is used to plot the Laffer curve for several elasticities, and to plot the newly introduced curve using the labor tax example. Results indicate that the U.S. could conceivably be operating in the prohibitive area, but that the tax wedge or labor supply elasticity would have to be much higher than most estimates would suggest.     

Income distribution and equilibrium multiplicity in a stigma-based model of tax evasion

This paper incorporates continuous income distribution into the stigma-based model of tax compliance. The paper investigates the effect of income distribution on the existence of multiple equilibria, and characterizes the conditions under which multiple equilibria emerge. Precisely, multiple equilibria exist if taxpayer incomes are sufficiently homogeneous, because the ‘social coordination effect’ dominates the ‘individual characteristics effect’. Numerical simulations show that the main proposition is robust to allowing two-step audit policies on the part of the tax agency, under the presumption that the best (or good) equilibrium is selected whenever there are multiple equilibria. As a byproduct, the effect of various forms of tax reforms on the optimal two-step audit policy, the equilibrium compliance, and fiscal revenue is analyzed.     

LABOUR MOBILITY AND TRANS‐TASMAN CURRENCY UNION*

The prospect of a common currency for Australia and New Zealand has been canvassed by senior poli‐ticians and bureaucrats, and has been the subject of academic debate. According to Mundell (1961 ), a high degree of internal labour mobility is a desirable feature of currency unions. This study looks at the extent to which long‐term migration between Australia and New Zealand responds to output shocks. Estimated VAR models and panel Granger‐causality tests demonstrate that shocks to relative per capita output have a significant and symmetrical impact on migration flows between Australia and New Zealand, and most of the impact is felt after about one year. Separating the shocks to Australia and New Zealand shows that ‘pull’ effects are more important than ‘push’ effects. Additionally, the trajectory of the Australian economy proves particularly influential for the choice of New Zealand emigrants. Although permanent migration responds intuitively to the state of the economy in Australia and New Zealand, the level of these migration flows is low in comparison to Australian inter‐state migration; yet it is high in relation to any third country.     

In the wake of austerity: social impact bonds and the financialisation of the welfare state in Britain

This paper provides an analysis of the financialisation of the British welfare state. In a continuation of neo-liberal privatisation and labour market activation, the financialised welfare state pursues a policy of welfare retrenchment, while engaging in forms of social engineering aimed at producing self-responsibilised individuals and communities who are financially literate, ‘investment-ready’ and economically productive. New financial instruments such as social impact bonds are deployed to these ends, both to ‘solve social problems’ and enable cost saving. Through the use of such financial instruments, the implementation of regulatory infrastructures and tax incentives, the financialised welfare state becomes a vehicle for the transfer of wealth from the public to private investors, while subjecting the domain of social policy to the vicissitudes of global financial markets. This paper offers a critique of these developments, situating the case of Britain within the broader global context and with regard to the implications for understanding the current political economy of the welfare state.