Optimal income taxation and migration

We tackle the issue of optimal dynamic taxation of capital income in an economy with disconnection as in Weil (J Public Econ 38:183–198, 1989), generated by migration and intra-family altruism. We show that, when the government aims at correcting such a disconnection using time-varying weights in the social welfare function, then there is room for nonzero capital income taxation, both in the short and in the long run.     

Optimal taxation and OECD labor taxes

We derive simple expressions for optimal labor taxes under different assumptions about government bond markets. We use these to examine OECD labor taxes, estimate the excess burden of taxation and assess the ability of optimal tax models to match the data.Optimal labor taxes are driven by: (i) a term reflecting Ramsey considerations which makes labor taxes vary positively with employment and (ii) a martingale component, reflecting the excess burden of tax, which shows persistent responses to shocks to the government's intertemporal budget constraint. Under complete markets (when governments can issue a full set of contingent securities) only the first factor is relevant. We find substantial evidence that incorporating incomplete markets into the optimal taxation model is critical for empirical success. However, we find strongest support for the martingale component and only weak evidence for the Ramsey component.     

Redistributive taxation and social insurance under adverse selection in the insurance market

This paper extends the analysis of optimal income taxation under uncertainty studied by Cremer and Pestieau (International Tax and Public Finance, 3, 281–295, 1996). We introduce asymmetric information in the insurance market whereby private insurance companies cannot identify the risk probability of the agents, and we examine its effect on public policy. We consider the separating equilibrium of Rothschild and Stiglitz (Quarterly Journal of Economics, 90, 629–649, 1976) and Riley (Econometrica, 47, 331–359, 1979) where the low risk agent is only partially insured. The presence of the distortion in the insurance market changes the affinity of labor, and in some cases, we show that the scope of redistribution and the resulting social welfare are higher under asymmetric information than under full information. We also show that the increase in social insurance affects the utility and labor incentive of the low risk type by relaxing the self-selection constraint in the insurance market. The policy implications of the redistributive taxation and social insurance are analytically and numerically examined.      

Disability insurance and optimal income taxation

This paper studies the design of disability insurance scheme when agents differ in their privately known productivity. We extend the Diamond and Mirrlees (1978) two period model to allow for agents differing ex-ante in their productivity and characterize the optimal nonlinear tax transfer that maximizes a utilitarian welfare function when per-period earnings and age are observable while individuals’ productivity and health status are not observable. We show that the induced tax/benefit scheme should exhibit a marginal income tax that decreases with age for some agents. A marginal subsidy on the young high productive income may be desirable. While the disability scheme always involves the old low productive agents to be indifferent between working and claiming disability benefits, this result is not always true for the old high productive agents. JEL Classification H55 · H23 · E62     

Optimal portfolio choice for investors with industry-specific labor income risks

We study optimal investment decisions for long-horizon investors with industry-specific labor income risks. We find that in addition to the volatility of labor income growth, the correlation between labor income and risky asset returns is another important factor that affects the optimal portfolio decisions and may provide a plausible explanation for the mixed empirical evidence of the relationship between labor income risk and portfolio holdings. Depending on its relative covariance with stock and bond returns, labor income may help resolve or deepen the asset allocation puzzle.     

Housing policy and the progressivity of income taxation

Most countries have tax provisions and subsidies to promote homeownership. These provisions generate an asymmetry in the tax treatment of owner- and rental-occupied housing, which affects the incentives to supply tenant-occupied housing. This paper analyzes the quantitative importance of the interaction of these provisions with the progressivity of income taxation in the context of an overlapping generations model with housing and rental markets. The model replicates the key facts observed in the economy, as well as distributional patterns of ownership, house size, and landlord behavior. The model suggests that the progressivity of income taxation can amplify or mitigate the effects of the asymmetries with important implications for housing tenure, housing consumption, portfolio reallocations, and welfare that differ from those reported in the literature.     

Uninsurable investment risks and capital income taxation

This paper studies the capital accumulation and welfare implications of reducing capital income taxation in a general equilibrium economy with uninsurable investment risks. It has been shown that, with uninsurable investment risks, under-accumulation of capital may result compared to the complete markets economy. We show that reducing somewhat the capital income tax rate increases the capital stock and leads to a welfare gain. The complete elimination of the capital income tax, however, is not necessarily welfare improving.     

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 top incomes

In many high-income countries over the past three decades there has been both large growth in inequality of wages and income and a shift in the burden of taxation from the top to the middle of the income distribution. A literature has developed which focuses on optimal tax rates for the top 1 % of the income distribution. In contrast, this paper considers the effect of inequality growth on the structure of a piecewise linear tax system defined over the entire income distribution. Our results suggest that the appropriate response to the increases in inequality would have been a shift towards a tax system with a lower tax rate in the lower half of the distribution together with a highly marginal rate progressive structure in the upper half, a clear differentiation between the top 10 % and the top 1 % and a higher top tax rate. Further inequality growth strengthens these characteristics of the optimal tax structure.     

Capital income taxation and economic growth in open economies

Can reductions in domestic capital income taxes attract foreign capital and, at the same time, foster economic growth? Using a two-country overlapping generations model with endogenous growth and internationally mobile capital, this paper shows that the effect of domestic capital taxes on the international allocation of capital and on the rate of economic growth do not necessarily go in the same direction. A country can attract capital by reducing its taxes, but this may lower the rate of economic growth depending on the elasticity of saving to the net-of-tax interest rate and on the effect of taxes on domestic factor productivity.     

Optimal taxation in the presence of bailouts

The termination of a representative financial firm due to excessive leverage may lead to substantial bankruptcy costs. A government in the tradition of Ramsey (1927) may be inclined to provide transfers to the firm so as to prevent its liquidation and the associated deadweight costs. It is shown that the optimal taxation policy to finance such transfers exhibits procyclicality and history dependence, even in a complete market. These results are in contrast with pre-existing literature on optimal fiscal policy, and are driven by the endogeneity of the transfer payments that are required to salvage the financial firm.     

Redistributive taxation and social insurance

This paper studies the role of social insurance as a redistributive mechanism in presence of an optimal (linear or general) income tax. It considers a second-best setting with two unobservable individual characteristics: ability, measured by the wage rate and risk, measured by the probability of incurring a loss. It shows that both tax progressivity and the optimal level of social insurance crucially depend on the correlation between ability and risk.This paper has been prepared for the IIPF 51 st Congress held in Lisbon, August 21–24, 1995. The authors are grateful to F. Gahvari, M. Lundholm, M. Marchand, J.-C. Rochet, P. Sørenson and the referees for their comments.     

Effective labor taxation and the international location of headquarters

Profit taxes are widely acknowledged to influence the location of firms’ headquarters. This paper sheds light on the role of aspects of labor taxation for the international location of headquarters. While profit taxes can be avoided in various ways, it is much harder for firms to manipulate the firm-specific labor tax base so that labor taxes may be relatively important for firm location. We construct a unique data set of effective labor taxes in 120 countries and use data on the location of 35,206 firms to analyze the impact of labor income tax rates, the progressivity of the income tax schedule, and social security contributions on firms’ decisions where to locate their headquarters. The findings suggest that both a higher progressivity of the tax system and higher (employee- and employer-borne) social security contributions negatively influence a country’s attractiveness for headquarters location. Hence, a one percentage point increase in these payroll taxes, reduces the probability of a country to attract headquarters by 6.1 %. The results prove robust in various empirical model specifications and subsets of the data.     

Corporate income taxation in Lithuania in the context of the EU

This paper explores Lithuania's competitiveness in the area of corporate income taxation. In order to assess how much freedom of action the country has in designing its own corporate income tax policy, the process of EU tax harmonization is analyzed by evaluating justification for tax harmonization, the major developments and the main outcomes of this process. Lithuania's corporate income tax system is compared with the systems in the other EU countries. Following a macro backward-looking approach, the paper calculates the measures of effective profit tax burden. Effective tax burden measures are computed for the whole enlarged EU. Such calculations are still rare in the economic literature.     

Assessing the international spillover effects of capital income taxation

Changes in capital taxes by one economy spill onto other economies with internationally mobile capital. We evaluate these impacts using a two-region, intertemporal general equilibrium model. The foreign economy's unilateral reduction in corporate income taxation has positive but small effects on U.S. welfare. In contrast, unilateral reductions in personal income taxation impose large negative spillovers. The differences result from CIT being source-based and PIT residence-based. The CIT cut reduces tax burdens to U.S. residents who invest abroad, while the PIT cut reduces foreigners' tax burdens only. Through general equilibrium adjustments neglected in simpler models, the PIT cut lowers U.S. residents' welfare.     

Tax competition and fiscal equalization under corporate income taxation

This paper challenges the view that tax base equalization by the so-called representative tax system (RTS) removes inefficient undertaxation in corporate tax competition. The innovation of the paper is that it focuses on a tax on corporate income, instead of the unit tax on capital considered in previous studies. We employ a tax competition model with fiscal equalization and show that the RTS fails to fully internalize pecuniary and fiscal externalities. As a consequence, the RTS yields inefficiently low tax rates in the Nash equilibrium of the tax competition game between governments. Tax revenue equalization performs even worse, but combined with equalization of private income it implements the efficient tax rates on corporate income.     

Human capital and optimal positive taxation of capital income

This paper analyzes optimal linear and non-linear taxes on capital and labor incomes in a life-cycle model of human capital investment, financial savings, and labor supply with heterogenous individuals. A dual income tax with a positive marginal tax rate on not only labor income but also capital income is optimal. The positive tax on capital income serves to alleviate the distortions of the labor tax on human capital accumulation. The optimal marginal tax rate on capital income is lower than that on labor income if savings are elastic compared to investment in human capital, substitution between verifiable and non-verifiable inputs in human capital formation is difficult, and most investments in human capital are verifiable so that education subsidies can directly reduce the tax wedge on learning. Numerical calculations suggest that the optimal marginal tax rate on capital income is substantial.     

Capital income taxation and risk taking under prospect theory

This research examines capital income taxation for a prospect theory investor under some acceptable in the literature reference levels relative to which are the changes in the level of wealth valued. Depending on the reference level, some results indicate that it is possible for a capital income tax increase not to stimulate risk taking even if the tax code provides attractive full loss offset provisions. However, risk taking can be stimulated when investors compare their reference level with others. Risk taking can increase also if the investor interprets part of the tax as a loss instead as a reduced gain. Then the investor becomes risk seeking and moves away from the discomfort zone of relative losses. This later response to taxation causes private risk taking to increase.     

Personal taxation of capital income and the financial leverage of firms

Tax competition for capital has led to a trend where many countries levy lower taxes on interest income, often introducing differential taxation between interest and business income. This study analyzes the effect on firm debt usage. We exploit Germany’s 2009 tax reform, which introduced a final withholding tax on interest income with a flat rate 18 percentage points below the unchanged tax rate on income from unincorporated businesses, as a quasi-experiment. The results, based on firm-level panel data, indicate that firms increase their leverage when the tax rate on interest income decreases, albeit to a small degree.     

A simple asset pricing model with heterogeneous agents,uninsurable labor income and limited stock market participation

In this paper we study a simple two-period asset pricing model to understand the implications of uninsurable labor income risk and/or borrowing constraints, limited stock market participation, heterogeneous labor income volatilities, and heterogeneous preferences. We appraise the performance of each of these in matching moments of asset returns to the data and show that limited stock market participation generates a significantly large equity premium. We also show that the distribution of wealth between stock market participants and non-participants plays an important role in asset pricing, and that the effect of borrowing constraints on asset returns are similar to that of limited participation. Finally, we discuss the practical implications of our investigation, providing an appraisal of ongoing changes in asset returns.