Fiscal policy and private consumption behaviour: The Spanish case

In this article we analyse whether the Ricardian equivalence hypothesis is a valid approximation for Spains economic reality or whether there exist deviations from that situation which would be more in line with the conventional Keynesian perspective of the effects of debt on private consumption-savings decisions.Our aim is to contribute to the rather sparse empirical literature on the subject for the Spanish case. The analysis is based on annual aggregate data for Spain covering the years 1955 to 2000, and uses both the structural and the Euler equation approaches to test the neutrality proposition, and is thus to be considered as a generalization of foregoing work on the Spanish economy.The findings indicate that support for Ricardian equivalence is mixed, while we also find very little support for the Keynesian specification of consumption and fiscal policy.First revision received: March 2003 / Final version received: October 2003The authors wish to thank M. Ferré, J.M. González-Páramo, A. Marchante, P. Meguire, F. Pedraja, J.L. Raymond, J. Salinas and two anonymous referees for their helpful comments and suggestions on this paper. We also thank the participants in the V Encuentro de Economía Aplicada (Oviedo, Spain, June 2002) and the XVII Simposio de Análisis Económico (Salamanca, Spain, December 2002) for their comments. Any remaining defects are our responsibility. We also are grateful to the Institute for Fiscal Studies of Spain (Ministerio de Hacienda, Secretaría de Estado de Hacienda) for its financial support.     

Reported gross income and marginal tax rates: estimation of the behavioural reactions of Spanish taxpayers

This article estimates, for the Spanish personal income tax, the elasticity of reported gross income to marginal tax rates. The identification of this elasticity has been performed using the reform approved by Law 35/2006, which came into force in January 2007. The elasticities obtained suggest the existence of important efficiency costs, with significant regional differences. The average elasticity estimated for Spain as a whole is 0.676. However, this elasticity is highly dispersed throughout the Spanish administrative regions, which indicates the unequal power of distortion of the tax. Thus, households whose principal source of income is salary display an elasticity of 0.337, compared to 0.682 for households whose main income source comes from business or savings. Lastly, a positive correlation is also detected between elasticity and income level: an elasticity of 3.6 is reached for taxpayers with an annual gross income exceeding 100 000€.     

Employment- and growth effects of tax reforms

Since the mid-1990s almost all OECD countries have engaged in fundamental reforms of their tax systems. There is a trend towards higher social security contributions and lower tax rates on personal and corporate income. This paper explores whether these tax policy measures are effective means for reducing unemployment and accelerating economic growth. Using a Pissarides type search model with endogenous growth, we analyze how savings and the incentive to create new jobs are affected by revenue-neutral tax swaps between wage income taxes, payroll taxes, capital income taxes and taxes levied on capital costs. In our framework, cutting the capital income tax (reducing the double taxation of dividend income) financed by a higher payroll tax turns out to be superior, such a policy mix fosters both employment and growth. Most other tax reforms imply a trade-off between employment and growth.     

Social Comparisons and Optimal Taxation in a Small Open Economy

In this paper, we analyze how international capital mobility affects the optimal labor and capital income tax policy in a small open economy when consumers care about relative consumption. The main results crucially depend on whether the government can tax returns on savings abroad. If the government can use flexible residence‐based capital income taxes, then the optimal policy rules from a closed economy largely carry over to the case of a small open economy. If it cannot, then capital income taxes become completely ineffective. The labor income taxes must then indirectly also reflect the corrective purpose that the absent capital income tax would have had.     

Capital income taxation,tax criteria,and intergenerational welfare

In a two-period overlapping-generations model, residence criteria are shown to be optimal with lump-sum transfers to the younger generation in a dynamically efficient open economy even if all wage income, corresponding to rent income under exogenous labor supply, is not taxed away. When tax revenues are also distributed to the older generation — which indeed may be desirable for short-term intergenerational welfare distribution reasons — a weighted average rule is derived for optimal international taxation. The taxation of domestic savings income follows the inverse elasticity rule in respect to savings and, surprisingly, higher investment elasticity increases the tax level. Finally, for a small open economy and for large identical economies, tax competition with a mixed scheme of residence-based taxes and source-based subsidies yields the same tax policy as tax cooperation with no restrictions on the domestic and international capital income tax instruments.     

Public policy,dynamic status preferences,and wealth inequality

This paper studies the effect of productive government spending (taxation) on aggregate savings behavior and its consequences for the dynamics of wealth inequality, taking into consideration key behavioral changes that occur during the process of economic development. Substantial empirical evidence suggests that during this process agents' preferences toward status (positional consumption) evolves according to the average wealth of the society. The sources of wealth include private capital and productive public capital, the latter financed by a distortionary income tax. This dynamic status effect impacts peoples' responses to tax policy in ways which contrast with those of the standard neoclassical model. Specifically, we find that in response to an increase in the income tax, in economies with a strong (weak) enough dynamic status effect, savings and inequality increase (decrease). Incorporating the behavioral changes to fiscal policy expands the set of mechanisms available to explain the observed variations of savings and wealth distribution dynamics that cannot be attributed to technological or other structural factors.     

Understanding domestic savings: an empirical approach

ABSTRACT

There are two unusual and important features in the evolution of the savings rate in Chile. First, the economy increased the average savings rate by 11 percentage points in the period 1985–2013 compared to 1960–1984, mainly due to a large change in private savings rate (10 percentage points), and an additional 1 percentage point from the public sector. The second feature is related to the change in the composition of private savings. After several years of nearly no corporate savings, this component became an important part of total savings reaching an average of almost 10% of Gross National Disposable Income (GNDI) during the period 1986–2012. Our results show that the 1984 tax reform, the boost in the marginal productivity of capital and the deepening of the financial market were the main drivers that explain the dramatic increase in corporate savings. We also found that the reduction in personal income tax after the tax reform and the higher income per capita growth helped to explain the increase in household savings, while the structural balance rule helped to explain the increase in public savings.     

Taxation of capital income in overlapping generations economies

Whether capital income should be taxed in overlapping generations economies is vividly discussed. It is shown that intergenerational lump‐sum taxes cannot implement the Golden Rule allocation when agents have private information on their earnings potential. Hence, the seminal Atkinson–Stiglitz result that optimal income taxation pre‐empts any role for indirect taxation cannot be interpreted to imply that capital income taxation (affecting intertemporal relative prices) should not be taxed. Specifically, capital income should unambiguously be taxed in small open economies, and the optimal tax rate depends inversely on the elasticity of total savings to disposable income and the after‐tax rate of return.     

Scale-dependent and risky returns to savings: Consequences for optimal capital taxation

I present a model of optimal capital taxation where agents with heterogeneous labor productivity randomly draw their rate of return to savings. Because of scale dependence, the distribution of rates of returns can depend on the amount saved. Uncertainty in returns to savings yields an insurance rationale for taxing capital on top of labor income. I first show that, because of scale dependence, agents making the same saving decision should access the same rate of return at the optimum. I then constrain the information set of the government and show that, as soon as return are uncertain, positive capital income taxation is needed at the optimum. The optimal linear tax on capital income trades off insurance with distortions to both savings and to the rate of return in a context of scale dependence. Eventually, I argue that scale dependence in and of itself is not sufficient to justify capital taxation on top of labor income taxes. These results are still valid when agents can optimize between a risk-free and a risky-asset that can both exhibit scale dependence.     

Taxation, Human Capital Accumulation and Economic Growth

Previous studies have shown that tax rates and the growth rate of output are negatively related under the assumption that government wastes tax revenues. This paper shows that, if tax revenues are used for human capital accumulation, tax rates and the growth rate can be positively related. An increase in the human capital tax rate will increase (decrease) the growth rate when the initial tax rate is small (large). An increase in the physical capital tax rate will increase the growth rate when savings are completely interest-inelastic. The effects of income taxes and lump-sum taxes on growth are also analysed.
JEL Classification Numbers: E6, H2, O4.     

Taxation Reform: Some Economic Issues

The Australian system of Commonwealth and State taxes is in need of comprehensive reform. It fails the criteria of neutrality, horizontal equity and simplicity, it is not as progressive as often thought, and the future revenue base is declining. Many of the problems stem from the absence of comprehensive tax bases as applied to income, expenditure and assets, and related choice options are subjected to very different effective tax burdens. Important choice options facing different effective tax rates include: work and leisure; consumption and saving; different saving and investment options; form of labour remuneration; different ways of production; the mix of goods and services produced and consumed; and, domestic or overseas location.
A comprehensive income tax base is required, especially as applied to the taxation of capital income. The options of a nominal income, real income or expenditure base are explored.
It is argued that reform of indirect taxes proceed along two lines. The general revenue raising purpose leads to a comprehensive base of final consumption expenditure at a single rate. Then, additional specific taxes for user pays purposes, for example for roads, and for externalities, for example tobacco, set at the supply cost or net externality would be applied.
There are conflicting arguments for and against changing the tax mix away from income to expenditure.     

Replacing the U.S. income tax with a progressive consumption tax: A sequenced general equilibrium approach

This paper examines the welfare consequences of changing the current U.S. income tax system to a progressive consumption tax. We compute a sequence of single period equilibria in which savings decisions depend on the expected future return to capital. In the presence of existing income taxes, the U.S. economy is assumed to lie on a balanced growth path. With the change to a consumption tax, individuals save more and initially consume less. As the capital stock grows, consumption eventually overtakes that of the original path, and the economy approaches the new balanced growth path with higher consumption and a greater capital stock. Both the transition and the balanced growth paths enter our welfare evaluations. We find the discounted present value of the stream of net gains is approximately $650 billion in 1973 dollars, just over 1 percent of the discounted present value of national income. Larger gains occur if further reform of capital income taxation accompanies the change. We examine the sensitivity of the results, both to the design of the consumption tax and to the values of elasticity and other parameters. The paper also contains estimates of the time required to adjust from one growth path to the other.     

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.     

THE WELFARE GAINS OF AGE‐RELATED OPTIMAL INCOME TAXATION

Using an overlapping generations model with skill uncertainty and private savings, we quantify the gains of age‐dependent labor income taxation. The total steady‐state welfare gain of switching from age‐independent to age‐dependent nonlinear taxation varies between 2.4% and 4% of GDP. Part of the gain descends from relaxing incentive–compatibility constraints and part is due to capital‐accumulation effects. The welfare gain is of about the same magnitude as that which can be achieved by moving from linear to nonlinear income taxation. Finally, the welfare loss from tax‐exempting interest income is negligible under an optimal age‐dependent labor income tax.     

Optimal firm behaviour under different fiscal regimes

This paper presents a theoretical framework for studying tax effects on optimal entrepreneurial behaviour; this is done within the context of a partial equilibrium model of the firm. Several regimes of corporate income taxation are evaluated with respect to their (non-)neutrality characteristics. Subsequently, the degrees of tax shifting and tax compensation have been derived by means of a model specified in rather simple terms. Evaluating it numerically, we find that the Dutch regime tends to neutrality, or possibly to slightly negative non-neutrality.     

Some aspects of the taxation of capital gains

The analysis of the effects of capital gains taxation requires a careful modelling both of the details of the tax code and the imperfections in the capital market. Under the standard assumptions concerning perfect capital markets and under the standard idealizations of the tax code, there are several strategies by which rational investors can avoid note only all taxes on their capital income, but also all taxes on their wage income; these strategies leave individuals' consumption and bequests in each state of nature and at each date unchanged from what they would have been in the absence of taxes. Although certain detailed provisions of the tax code may limit the extent to which rational investors can avail themselves of these tax avoidance activities, there are ways, in a perfect capital market, by which the effects of these restrictions can be ameliorated. Accordingly, any analysis of the effects of capital taxation must focus on imperfect capital markets.If individuals face limitations on the amounts which they can borrow and/or if there are limitations on short sales, then under some circumstances there is a locked-in effect (individuals do not sell securities which they would have sold in the absence of taxation); but under other circumstances individuals are induced to sell securities that they otherwise would have held, in order to take advantage of the asymmetric treatment of short-term losses and long-term gains. A policy of realizing gains as soon as they become eligible for long term treatment dominates the policy of postponing the realization of capital gains, provided the gains are not too large.A simple general equilibrium model is constructed within which it is shown that the taxation of capital gains may increase the volatility of asset prices, and lead individuals not to trade when they otherwise would. While the analysis casts doubt on the significance of the welfare losses resulting from these exchange inefficiencies, there are circumstances in which the tax leads to production inefficiencies, e.g. terminating projects at other than the socially optimal date.Finally, we argue that the focus of some recent policy debates on the short-run revenue impact of a decrease in the tax rate on capital gains is misplaced: even when the short-run revenue impact is positive, consumption may increase (thus exacerbating inflationary pressures) and private savings may decrease (thus leading to a lower level of investment in the private sector). Moreover, there is some presumption that the long-run revenue impact is negative.Our analysis has some important implications for empirical research. In particular, it suggests that the impact of the tax is not adequately summarized by a single number, such as the ‘effective tax rate’ representing the average ratio of tax payments to capital gains. Moreover, the impact of the tax cannot be assessed by looking only at reported capital gains and losses.     

Generalized cash-flow taxation

We show the unique form that must be taken by a tax system based entirely on realization accounting to implement a uniform capital income tax, or, equivalently, a uniform wealth tax. This system combines elements of an accrual based capital income tax and a traditional cash-flow tax, having many of the attributes of the latter while still imposing a tax burden on marginal capital income. Like the traditional cash-flow tax, this system may be integrated with a tax on labor income. We also show how such a tax can be supplemented with an optional accounting for a segregated subset of actively traded securities, subjected separately to mark-to-market taxation at the uniform capital income tax rate, to permit a fully graduated tax system applicable to labor income.     

Tax Evasion and the Time Consistency of the Government's Income Tax Policy

It is shown that it is not necessarily optimal for the government to tax capital income at a high rate even when capital is in fixed supply because the supply of capital for tax purposes may be elastic if capital income tax evasion occurs. An example is given where the wage tax rate is positive and greater than the interest income tax rate even though capital is in fixed supply. Conditions are also derived under which the capital income tax rate is lower in the closed-loop policy game, where capital is fixed, than in the open-loop game, where it is not.
JEL Classification Numbers: E61, H26.     

Capital income taxation,depreciation allowances and economic growth: A perfect-foresight general equilibrium model

Conclusions The results indicated in Table 1 show that incomplete depreciation allowances reinforce the distortions in the equilibrium growth path brought about by an ideal capital income tax. A reduction in the deductible share of economic depreciation, like an increase in the tax rate, raises the current level of consumption, but reduces the steady state levels of consumption and capital per efficiency unit of labour.The reason for these distortions is that the tax law is able to drive wedges both between the rate of time preference and the market rate of interest, and between the latter and the marginal productivity of capital. The first wedge is created through capital income taxation as such and its size is directly related to the tax rate. The second wedge is created by the incomplete deductibility of depreciation. Its size is directly related to the tax rate and inversely to the deductible share of depreciation. For the distortion in the growth path of the economy it is the sum of the two wedges that counts. Therefore it is plausible that incomplete depreciation allowances reinforce the effects of capital income taxation.Knowing the determinants of the two wedges one can easily derive the influence of a tax reform on the marginal productivity of capital, the market rate of interest and the rate of time preference (cf. Table 2). In the short run, the system of these three interest rates is anchored by the marginal productivity of capital, and hence any measure that widens a wedge is translated into a reduction in the rate or those rates below the wedge. In the long run the system is anchored by the rate of time preference and an increase in the width of a wedge is translated into an increase in those rates or that rate above this wedge.The paper was written in association with the Sonderforschungsbereich 5 (Staatliche Allokationspolitik im marktwirtschaftlichen System).