Age-Dependent Taxation and the Optimal Retirement Benefit Formula

Abstract. This paper presents a comprehensive view of lifetime taxation including both explicit taxation through the general tax system and implicit taxation via the retirement benefit formula. Differences in productivity between individuals are unobservable, which provides a rationale for the use of distortionary taxes. It is shown that the optimal structure of age-dependent taxation can be characterized by a generalized Ramsey formula. Furthermore, the paper derives the optimal retirement benefit formula in the presence of the general tax system and examines the compatibility with the financial stability of the pension system.     

Optimal fiscal policy in the Uzawa-Lucas model with externalities

Summary. This paper devises a fiscal policy by means of which the first-best optimum equilibrium is attained as a market equilibrium in the Uzawa-Lucas model when average human capital has an external effect on productivity. The optimal policy requires the use of a subsidy to investment in human capital which can be financed by a tax on labor income. Lump-sum taxation is not required to balance the government budget either in the steady state or in the transitional phase. Physical capital income should not be taxed. Alternatively, the optimal growth path can be attained by means of a subsidy to human capital. Received: March 21, 2002; revised version: September 4, 2002 RID="*" ID="*" Financial support from the Spanish Ministry of Science and Technology through PNICDYIT grant SEC2002-03663 is gratefully acknowledged.     

On Optimal Lifetime Redistribution Policy

In this paper, we examine various aspects of the optimal lifetime redistribution policy within a cohort. We characterize the optimal tax policy when society consists of individuals who do not differ only in productivity, but also in time preference. We extend Diamond's analysis on nonlinear taxation of savings into the three-type and four-type models. To gain a better understanding of the lifetime redistribution, the problem is also solved numerically. Our results provide a rationale for distortions (upward and downward) in savings behavior in a simple two-period model where high-skilled and low-skilled individuals have different nonobservable time preferences beyond their earning capacity. If we interpret our model so that instead of private savings there is public provision of pension in the second period, then in the three-type model, we find a nonmonotonic pattern of the replacement rates. The numerical results suggest that retirement consumption is less dispersed than the first-period consumption in a paternalistic case. Paternalistic government policy also increases second-period consumption compared to the welfarist case.     

Optimal environmental taxation and enforcement policy

We study the optimal environmental taxation and enforcement policy when (i) the regulator does not know the firms’ abatement costs, (ii) penalties for tax evasion are limited, and (iii) monitoring of pollution is costly. We show that the threat of being audited alter the usual firms’ incentives to over-estimate their abatement costs. In particular, depending on the firms’ abatement costs, the optimal policy may involve over or under-deterrence compared to the full information outcome. We then investigate the properties of a pollution standard. We show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered.     

The Welfare Effects of Environmental Taxation

Recent literature has investigated whether the welfare gains from environmental taxation are larger or smaller in a second-best setting than in a first-best setting. This question has mainly been addressed indirectly, by asking whether the second-best optimal environmental tax is higher or lower than the first-best Pigouvian rate. Even this indirect question has itself been approached indirectly, comparing the second-best optimal environmental tax to a proxy for its first-best value, marginal social damage (MSD). On closer examination, however, MSD becomes ambiguously defined and variable in a second-best setting making it an unreliable proxy for the Pigouvian rate. Given these observations, the current analysis reevaluates these welfare questions and finds that when compared directly to its first-best value, the second-best optimal environmental tax generally rises with increased revenue requirements. Even in cases where the second-best environmental tax is lower than its first-best value, the welfare gains may be greater than in a first-best setting. These results suggest that the marginal fiscal benefit (revenue recycling effect) exceeds the marginal fiscal cost (tax base effect) over a range of environmental tax rates that, for benchmark models, extends above the first-best Pigouvian rate. These findings reinforce the intuition that environmental policy complements rather than competes with the provision of other public goods.     

Optimal Categorical Transfer Payments: The Welfare Economics of Limited Lump-Sum Redistribution

Despite their importance in tax-transfer systems, categorical transfer payments, based on (nearly) exogenous characteristics such as disability or date of birth, have been deemphasized in optimal-tax analysis. I use the well-developed theory of first-best redistribution to clarify the welfare economics of categorical transfers, which are a form of limited lump-sum redistribution. The comparison to first-best redistribution explains how categorical transfers affect groups' labor supplies and utility levels, why the use of categorical transfers is inversely related to the planner's inequality aversion, and why their use reduces the optimal income tax rate.     

Optimal taxation in the extensive model

We study optimal taxation under extensive preferences: the agents? utilities are constant for positive actions up to a maximal productivity level. Utilities may be discontinuous at the origin, reflecting fixed costs of participation. Allowing for general distributions of work opportunity costs and productivity and for income effects, we characterize optimal, incentive-compatible tax schedules. We then give sufficient conditions for society to desire redistribution. When these conditions hold, upward distortions of the financial incentives to work can only occur for low-skilled workers. Such upwards distortions are indeed always present when the fixed participation costs are pecuniary.     

Intergenerational policy and the measurement of tax incidence

We evaluate the ability of generational accounting to assess the potential welfare implications of policy reforms. In an intergenerational context policy reforms usually have redistributive, efficiency, and general equilibrium implications. Our analysis shows that when the policy reform implies changes in economic efficiency, generational accounts can be misleading not only about the magnitude of welfare changes, but also about the identity of who wins and who losses. In contrast, the generational accounts correctly identify welfare changes when the policy reform has only a pure intergenerational redistribution component. We illustrate and quantify this issue in the context of widely considered policy reforms (substitution of consumption for labor taxation, and the increase of retirement age) and in a more general context of optimal policy.     

Institutional inequality and tax incidence

This paper analyses the effects of taxation when inequality is not innate. A theory of institutional inequality is presented which employs a trade model with circular production and the theory of clubs. Inequality is introduced by constraints on entry into sectors and ‘local’ groups within sectors. Individual time is treated as a fixed factor of production, and work and leisure are re-defined. The analysis suggests that when inequality is institutional and government policy does not alter the mechanisms by which institutions translate the distribution of power into the distribution of income, a redistribution of income by conventional tax-transfer schemes may not always be feasible.     

Indirect taxation and the welfare effects of altruism on the optimal fiscal policy

This paper analyzes the welfare effects of altruism on the optimal fiscal policy. The existence of positive bequests links present and future generations in the economy. We show that these altruistic links provide a new role for indirect taxation (consumption and estate taxes) with important welfare implications. We use three different altruistic approaches (warm-glow, dynastic, and family) to illustrate how the presence of bequests in the budget constraint of the donee gives the government the ability to use indirect taxation to mimic lump-sum taxes and to implement the first-best outcome in the long-run. This channel is not present in economies without altruism, such as the infinite-lived consumer economy or the overlapping generations economy, where long-run welfare is suboptimal and indirect taxation is irrelevant.     

Optimal incentives for labor force participation

Optimal taxation is analyzed under a Rawlsian criterion in an economy where the only decision of the agents is to participate, or not, to the labor force. The model allows for heterogeneity both in the agent's productivities and aversions to work. At a first-best optimal schedule, the marginal agent who decides to work pockets all of her productivity, while being just compensated for her work aversion. When the planner does not observe work aversion, financial compensation for work is lower than productivity. Theory puts little restrictions on the shape of the optimal tax schedules. The usual first-order conditions involving the elasticities of participation only apply for sufficiently regular economies. We qualitatively show how the optimal incentive schemes depend on the underlying structure of the preferences: 100% marginal tax rates or subsidies to work are related to specific features of the economies.     

A theory of reverse retirement

The retirement system is usually regarded as giving a fair reward for a long working career. However, only workers who have a sufficiently long life benefit from that reward, but not workers who die prematurely. To re‐examine the fairness of retirement systems under unequal lifetime, this paper compares standard retirement (i.e., individuals work before being retired) with—hypothetical—reverse retirement (i.e., individuals are retired before working). We show that, under standard assumptions, an economy with reverse retirement, once in place, converges towards a unique stationary equilibrium. At the normative level, we show that, when labor productivity declines with age, reverse retirement cannot be optimal under the utilitarian criterion (unlike standard retirement), whereas reverse retirement can be optimal under the ex post egalitarian criterion (giving priority to the worst‐off in realized terms). Finally, we show that there exists a set of policy instruments that allow a government to organize a successful transition from standard to reverse retirement.     

Poverty alleviation and tax policy

This paper examines public good provision and tax policy—optimal non-linear income taxation and linear commodity taxation—when the government departs from purely welfarist objective function and seeks to minimise poverty. This assumption reflects much policy discussion and may help understand some divergences of practical tax policy from lessons in optimal tax analysis. In contrast to Atkinson and Stiglitz (J. Public Econom. 6 (1976) 55), it may be optimal to use differentiated commodity tax rates, including the taxation of savings, even if preferences are separable in goods and leisure. The optimal effective marginal tax rate at the bottom of the distribution may be negative, suggesting that wage subsidy schemes can be optimal. Finally, optimal provision of a public good is analysed under poverty minimisation.     

Social Desirability of Earnings Tests

Abstract. In many countries, pension systems involve some form of earnings test; i.e. an individual's benefits are reduced if he has labor income. This paper examines whether or not such earnings tests emerge when pension system and income tax are optimally designed. We use a simple model with individuals differing both in productivity and in their health status. The working life of an individual has two 'endings': an official retirement age at which he starts drawing pension benefits (while possibly supplementing them with some labor income) and an effective age of retirement at which professional activity is completely given up. Weekly work time is endogenous, but constant in the period before official retirement and again constant (but possibly at a different level), after official retirement. Earnings tests mean that earnings are subject to a higher tax after official retirement than before. We show under which conditions earnings tests emerge both under a linear and under a non-linear tax scheme. In particular, we show that earnings tests will occur if heterogeneities in health or productivity are more significant after official retirement than before.     

What you don't see can't hurt you: an economic analysis of morality laws

Abstract.  This paper provides an efficiency explanation for regulation of sex, drugs, and gambling. We propose that these 'morality laws' can be explained by considering some activities to impose a negative externality when the activity is observed . Efficiency requires discretion by the individual who engages in such activities. When discretion is difficult to regulate directly, the activities can instead be proscribed, thereby giving individuals incentive to hide their actions from others. We find conditions for the first-best levels of consumption and hiding to be implementable. Since some level of activity is efficient, the optimal sanctions are not maximal.     

On the design of optimal grandfathering schemes for emission allowances

This paper derives optimal schemes for the free allocation of emission allowances in a dynamic context. We consider emissions- and output-based allocation rules which allow for updating of the basis of allocation over time and thereby do not rely on historical data only. We show that such dynamic schemes do not necessarily induce inefficient outcomes. In closed trading systems with an absolute cap on emissions, grandfathering schemes which allocate allowances proportionally to past emissions are first-best. However, in open trading systems where allowances can be traded with outsiders, first-best allocation schemes must not depend on firm-specific decisions while second-best schemes correspond to a Ramsey rule of optimal tax differentiation and are generally based on both past emission and output levels.     

Distortionary company car taxation: deadweight losses through increased car ownership

We analyse the effects of distortionary company car taxation through increased household car consumption for the Netherlands. We use several identification strategies and demonstrate that for about 20 % of households company car possession increases car ownership. The annual welfare loss of distortionary company taxation through increased car ownership is generally rather small, maximally €120 per company car, and much less than the welfare loss through increased expenditure on the company car. However, for policies that exempt households from paying tax on their company car, the annual deadweight loss is likely higher. Our first-best tax policy recommendation is to increase company car tax rates. However, our current results suggest that a second-best policy, which keeps average company car taxation constant but which reduces the marginal tax on cheaper cars and increases the marginal tax on expensive cars, would be welfare improving as overconsumption of company cars will be reduced.     

Good Jobs,Bad Jobs and Redistribution*

We analyse the question of optimal taxation in a dual economy, when the policy‐maker is concerned about the distribution of labour income. Income inequality is caused by the presence of sunk capital investments, which creates a “good jobs” sector due to the capture of quasi‐rents by trade unions. With strong unions and high planner preference for income equality, the optimal policy is a combination of investment subsidies and progressive income taxation. If unions are weaker, the policy‐maker may instead choose to tax investment.     

Fiscal Policy when Individuals Differ with Regard to Altruism and Labor Supply

This paper studies the incidence of tax-transfer policy in a growth model wherein individuals differ according to their level of intergenerational altruism and have an endogenous labor supply. The main result is that public debt is neutral at the macro level but redistributes resources from nonaltruists to altruists. Capital income taxation can hurt the nonaltruists who do not have any wealth more than it hurts the altruists who own all of it. Whether or not the altruists supply a positive amount of labor makes a big difference as to the incidence of alternative tax transfer policies.     

Increasing life expectancy and optimal retirement in general equilibrium

We analytically assess the effects of changes in longevity on the interest rate, the consumption-savings behavior, and the optimal retirement decision within a dynamic general equilibrium setting. We derive a simple sufficient condition for which the optimal retirement age always increases with life expectancy. Numerical assessment reveals that for realistic parameter values that reflect the situation in industrialized countries, the optimal retirement age indeed increases with life expectancy and the sufficient condition tends to be fulfilled. Together with the fact that the actual retirement age did not increase in industrialized countries over the last decades, while there have been large improvements in longevity, this leads us to conclude that strong monetary and institutional incentives for early retirement exist and these counteract the effects of increasing life expectancy. Our policy conclusion is that the retirement age should be partially linked to life expectancy and that incentives for early retirement should be removed.