Income Shifting within a Dual Income Tax System: Evidence from the Finnish Tax Reform of 1993*

Dual income tax systems can suffer from income that shifts from progressively taxed labour income to capital income, which is taxed at a lower, flat rate. This paper empirically examines the 1993 Finnish dual income tax reform, which radically reduced the marginal tax rates on capital income for some, but not all, taxpayers. We measure how overall taxable income and the relative shares of capital income and labour income reacted to the reform. We find that the reform led to a small positive impact on overall taxable income, but part of the positive response was probably offset by income shifting among the self‐employed.     

Identifying Laffer Bounds: A Sufficient‐Statistics Approach with an Application to Germany

We derive a simple sufficient‐statistics test for whether a nonlinear tax‐transfer system is second‐best Pareto efficient. If it is not, then it is beyond the top of the Laffer curve and there exists a tax cut that is self‐financing. The test depends on the income distribution, extensive and intensive labor supply elasticities, and income effect parameters. A tax‐transfer system is likely to be inefficient if marginal tax rates are quickly falling in income. We apply this test to the German tax‐transfer system, and we find that the structure of effective marginal tax rates is likely to be inefficient in the region where transfers are phased out.     

Shifting Taxes from Labor to Consumption: More Employment and more Inequality?

This paper investigates the effect of shifting taxes from labor income to consumption on labor supply and the distribution of income in Germany. We simulate stepwise increases in the value‐added tax (VAT) rate, which are compensated by revenue‐neutral reductions in income‐related taxes. We differentiate between the personal income tax (PIT) and social security contributions (SSC). Based on a dual data base and a microsimulation model of household labor supply behavior, we find a regressive impact of such a tax shift in the short run. When accounting for labor supply adjustments, the adverse distributional impact persists for PIT reductions, while the overall effects on inequality and progressivity become lower when payroll taxes are reduced. This is partly due to increases in aggregate labor supply, resulting from higher work incentives.     

The taxation of passive foreign investment: lessons from German experience

Abstract The paper evaluates the working of German CFC rules that restrict the use of foreign subsidiaries located in low‐tax countries to shelter passive investment income from home taxation. While passive investments make up a significant fraction of German outbound FDI, we find that German CFC rules are quite effective in restricting investments in low‐tax jurisdictions. We find evidence that the German 2001 tax reform, which unilaterally introduced exemption of passive income in medium‐ and high‐tax countries, has led to some shifting of passive assets into countries for which the exemption was previously limited.     

Less than single dividend taxation: A note

The taxation in Norway of corporate and dividend income makes it attractive for individuals in high tax brackets to earn their income through corporations, as dividends. This kind of incentive has been assumed in the literature to be non-existing because of its adverse effects.     

Ad‐valorem tax incidence and after‐tax price adjustments: evidence from Brazilian basic basket food

Abstract Recent empirical work on tax incidence suggests that after‐tax price responses are independent of the tax change direction. This paper investigates asymmetric price responses to ad‐valorem tax changes in the Brazilian food market for 10 goods in 16 states during the period 1994–2008. Our results suggest that when tax rates increase, tax full shifting occurs for 2 of the 10 goods and tax overshifting occurs for one of the 10 goods; the price response to tax cuts is an undershifting for all goods. Moreover, this last result is similar to our estimation of (average) tax incidence (undershifting). We also investigate the short‐term and long‐term relationships between prices and VAT rate parameters and find that prices seem to respond to tax shocks within four months.     

Supply-Side Economics of Germany's Year 2000 Tax Reform: A Quantitative Assessment

Abstract. The paper provides an assessment of supply‐side economics following Germany's year 2000 tax reform. Investigated are a corporate tax cut, deteriorating depreciation allowances and imputation rules, and a private income tax cut. For this purpose, a neoclassical growth model is augmented by various fiscal policy parameters and endogenous corporate finance and calibrated with German data. The model is used to evaluate consequences of Germany's tax reform on production, firm finance and leverage, investment, consumption and welfare of a representative household.     

Dividend taxation and intertemporal tax arbitrage

We analyze the effects of changes in dividend tax policy using a life-cycle model of the firm, in which new firms first access equity markets, then grow internally, and finally pay dividends when they have reached steady state. We find that unanticipated permanent changes in tax rates have only small effects on aggregate investment, since macroeconomic dynamics are dominated by mature firms for which dividend taxation is not distortionary. Anticipated or temporary dividend tax changes, on the other hand, create incentives for firms to engage in inter-temporal tax arbitrage so as to reduce investors' tax burden. For example, a temporary tax cut – the type most likely to be enacted by policymakers – induces firms to accelerate dividend payments while tax rates are low, which reduces their cash holdings and makes them capital-constrained when large investment opportunities arise. This can significantly lower aggregate investment for periods after the tax cut.     

HUMAN CAPITAL FORMATION AND TAX EVASION

A strictly risk‐averse individual with an exogenous gross income in period one can acquire human capital in the same period and evade taxes. Period‐two income rises with educational investments in period one and can also be hidden from tax authorities. It is shown that a greater tax deductibility of educational investments and higher individual ability induce a positive correlation between tax evasion and educational investments in period two, whereas the relationship in period one is ambiguous. These theoretical predictions can explain diverse empirical findings on the correlation between education and tax evasion.     

TAXES,REGULATIONS AND THE CORPORATE DEBT MARKET*

Outstanding credit market debt in the U.S. corporate sector increased dramatically over the second half of the 20th century. During this period, tax rates on dividend distributions and corporate income decreased. This article argues that the observed decline in dividend and corporate income tax rates generated an improvement in the collateral value of corporate assets and led to an increase in U.S. corporate debt. To analyze this conjecture, we build a general equilibrium model with enforcement constraints that induce endogenous limits on debt financing. We find that the model can account for the time‐series features of U.S. corporate debt data.     

Does dividend tax impede competition for corporate charters?

We develop a model of jurisdictional competition for corporate charters among the states in which a firm’s agency cost depends on the federal dividend income tax rate and the takeover regulations of its domicile state. When firms are mobile across states, the federal dividend income tax rate affects both the intensity of competition among the states and the equilibrium level of state takeover regulations. Our model shows that increasing dividend tax rate weakens the competition for corporate charters under a condition: dividend-paying and the market for corporate control are complementary corporate governance mechanisms. This condition holds empirically, suggesting that dividend tax not only discourages firms from paying dividends but also weakens their corporate governance by disincentivizing states to improve their corporate laws.     

Distributional Effects of a Wealth Tax under Lifetime‐Dynastic Income Concepts*

Annual wealth tax is back on the policy agenda, but discussion of its effect is not well informed. When standard methodology is used and wealth‐tax burdens are measured against annual individual income, it is found that a large share of the tax burden falls on people with low incomes. In this study, we use rich Norwegian administrative data to discuss the distributional effects of wealth tax under several different income concepts, ultimately measuring income over the lifetime of family dynasties. When measured against lifetime income and lifetime income in dynasties, wealth tax is mostly borne by high‐income taxpayers and is seen as clearly redistributive.     

REDISTRIBUTIVE POLITICS AND GOVERNMENT DEBT IN A BORROWING‐CONSTRAINED ECONOMY

We develop a two‐period, three‐class of income model where low‐income agents are borrowing constrained because of capital market imperfections, and where redistributive expenditure is financed by tax and government debt. When the degree of capital market imperfection is high, there is an ends‐against‐the‐middle equilibrium where the constrained low‐income and the unconstrained high‐income agents favour low levels of government debt and redistributive expenditure; these agents form a coalition against the middle. In this equilibrium, the levels of government debt and expenditure might be below the efficient levels, and the spread of income distribution results in a lower debt‐to‐GDP ratio.     

The effect of the tax reform act of 1986 on the location of assets in financial services firms

This paper examines the effects of the Tax Reform Act of 1986 on the international location decisions of U.S. financial services firms. The Act included rule changes that made it substantially more difficult for U.S. firms to defer U.S. taxes on overseas financial services income held in low-tax jurisdictions. We use information from the tax returns of U.S. corporations to examine how local taxes affect the allocation of financial assets held abroad by financial services firms. We find that, before the Act, the location of reported assets in financial subsidiaries was responsive to differences in host country tax rates across jurisdictions. However, after the Act, differences in host country tax rates no longer explain the distribution of assets held in financial services subsidiaries abroad. Our results suggest that the tightening of the anti-deferral provisions applicable to financial services companies has been successful in diminishing the effect of host country income taxes on asset location decisions.     

THE POTENTIAL FOR SHORT‐RUN SHIFTING OF A CORPORATE PROFITS TAX

Can the owners of a firm shift a corporate profits tax to consumers? Not in the short run if the tax is stated as a proportion of profits and the firm is a profit maximizer. But what if the firm wishes to pursue a strategy other than profit maximization, say revenue maximization subject to a profit constraint? Under such a condition the firm's reaction to a tax or tax increase might be a price rise that captures part of the foregone profits. We show that firms which operate at a point on their demand curve that differs from profit maximization have an incentive to raise price in response to the tax – and that high cost firms have a greater incentive to raise price than do low cost firms. Our empirical analysis of the US beer industry confirms this finding, and sheds light on the Krzyzaniak–Musgrave analysis of the 1960s which suggested that the corporation income tax produced significant short‐run shifting.     

Sharing the Burden? Empirical Evidence on Corporate Tax Incidence

This study investigates the direct incidence of the corporate income tax (CIT) through wage bargaining, using an industry‐region level panel dataset on all corporations in Germany over the period 1998–2006. For the first time we account for employment effects which result from tax‐induced wage changes. Workers share in reductions of the CIT burden; yet, the net effect of wage bargaining on the corporate wage bill, after an exogenous €1 decrease in the CIT burden, is as little as 19–28 cents. This is about half of the effect obtained in prior literature focussing on wages alone.     

Viewpoint: Innovations in the theory and practice of redistribution policy

Abstract We present a survey of key results from second‐best optimal redistribution theory and their implications for tax‐transfer policy. The core results include the Corlett‐Hague theorem, the Deaton conditions, the production‐efficiency theorem, the Atkinson‐Stiglitz theorem, and the Mirrlees‐Saez characterization of the optimal non‐linear income tax system. These have been augmented in recent years by optimal participation tax rates, the implications of involuntary unemployment, the use of unconventional instruments, such as minimum wages, in‐kind transfer, and workfare, and the optimal taxation of capital income and bequests.     

The dual nature of public goods and congestion: the role of fiscal policy revisited

Abstract The role of fiscal policy is examined when public goods provide both productive and utility services. In the presence of congestion, the consumption tax is shown to be distortionary. Optimal fiscal policy involves using consumption‐based instruments in conjunction with the income tax. An income tax‐financed increase in government spending dominates both lump‐sum and consumption tax‐financing. Replacing the lump‐sum tax with an income tax to finance a given level of spending dominates introducing an equivalent consumption tax. These results contrast sharply with the literature, where the consumption tax is generally viewed as the least distortionary source of public finance.     

Redistributive Taxation under Ethical Behaviour*

We consider the implications of ethical behaviour on the effect of a redistributive tax‐transfer system. In choosing their labour supplies, individuals take into account whether their tax liabilities correspond to what they view as ethically acceptable. If tax liabilities are viewed as ethically acceptable, a taxpayer behaves ethically, does not distort her behaviour, and chooses to work as if she were not taxed. On the other hand, if ethical behaviour results in tax liabilities that exceed those that are ethically acceptable, she behaves egoistically (partially or fully), distorts her behaviour, and chooses her labour supply taking into account the income tax. We establish taxpayers' equilibrium behaviour and obtain that labour supply is less elastic when taxpayers may behave ethically than when they act egoistically. We characterise and compare the egoistic voting equilibrium linear tax schedules under potentially ethical and egoistic behaviour. We also compare our results to those obtained under altruism, an alternative benchmark.     

Effective Taxation of Top Incomes in Germany

We exploit a dataset that includes the individual tax returns of all taxpayers in the top percentile of the income distribution in Germany to pin down the effective income taxation of households with very high incomes. Taking tax base erosion into account, we find that the top percentile of the income distribution pays an effective average tax rate of 30.5% and contributes more than a quarter of total income tax revenue. Within the top percentile, the effective average tax rate is first increasing, then decreasing, with income. Since the 1990s, effective average tax rates for the German super‐rich have fallen by about a third, with major reductions occurring in the wake of the personal income tax reform of 2001–05. As a result, the concentration of net incomes at the very top of the distribution has strongly increased in Germany.