Optimal tax perturbations

The paper considers an economy with H households, N+1 commodities and M fixed factors with commodity taxes and government expenditures on goods and services. The paper studies under what conditions (small) Pareto improving tax changes exist, i.e., tax changes which increase the utility of each household in the economy. The basic analytical technique used is just the usual comparative statics apparatus, except that duality theory is used in order to simplify the computations. The paper derives both the changes in prices and in real incomes that are induced by (small) changes in exogenous tax variables (differential real income balanced budget incidence analysis).     

A quantitative theory of tax evasion

I present a simple, unified approach to study the tax evasion practices often observed in developing countries. I develop a general equilibrium model where heterogeneous establishments optimally select themselves into informality, tax compliance, and formal tax evasion. Informal firms evade taxes by staying small, while larger, formal firms can engage in costly tax evasion. In equilibrium, tax revenues rely on medium-sized firms, which are scarce. In a calibration exercise using data from Mexico, I find that reducing the returns to tax evasion by formal firms increases tax revenues by up to 68%. However, economies where such returns are too high face a trade-off between tax collection and aggregate efficiency, as cracking down on formal tax-evading firms pushes some firms into informality. Last, as the economy develops, the informal sector shrinks, while the tax-evading sector expands, thus limiting potential collection. If lower informality is a byproduct of development, and not vice versa, a solid tax base can be achieved by fiscal authorities effectively by focusing on formal tax evasion.     

Value-added tax and the theory of tax incidence

A value-added tax is examined in a general-equilibrium model of tax-incidence incorporating primary factors and intermediate goods. Production coefficients are variable and demand is elastic. The principal result is that under assumptions of fixed coefficients and inelastic demand which have been commonly employed in the literature, VAT as well as the corporation income tax will be neutral. In the more general setting of this paper, only VAT, applied to every industry at equal rates, will not affect relative factor and commodity prices. Incidence and other economic effects of a partial VAT are also discussed.     

Bunching and second-order conditions: A note on optimal tax theory

We present in this note a simple non-linear taxation model in which the agents are indexed by a one-dimensional parameter. Our purpose is to propose a method of resolution and to compute the optimal solution. We point out that the solution could not always be obtained with a simple derivation of the first-order conditions of the control problem under consideration, and we show the necessity to take into account the second-order conditions.     

Optimal tax treatment of the family: Married couples

This paper examines the appropriate tax treatment of the family in a series of analytical models and numerical examples. For a population of taxpaying couples which differ in earning capacity, we drive the optimal tax rates for each potential earner. These rates depend crucially upon own and cross labor supply elasticities and the joint distribution of wage rates. Our results suggest that the current system of income splitting in the United States, under which husbands and wives face equal marginal tax rates, is nonoptimal. Using results from recent econometric studies, and allowing for a sensitivity analysis, the optimal tax rates on secondary workers in the family are much lower than those on primary earners. Indeed, our best estimate is that the secondary earner would face tax rates only one-half as high as primary earners.     

Optimal income taxation with tax avoidance

We determine the optimal income tax schedule when individuals have the possibility of avoiding paying taxes. Considering a convex concealment cost function, we find that a subset of individuals, located in the interior of the income distribution, should be allowed to avoid taxes, provided that the marginal cost of avoiding the first euro is sufficiently small. This contrasts with the results of Grochulski who shows that, using a subadditive cost function, all individuals should report their true income. We also provide a characterization of the optimal income tax curve.     

Measuring tax efficiency: A tax optimality index

This paper introduces an index of tax optimality that measures the distance of some current tax structure from the optimal tax structure in the presence of public goods. This index is defined on the [0, 1] interval and measures the proportion of the optimal tax rates that will achieve the same welfare outcome as some arbitrarily given initial tax structure. We call this number the Tax Optimality Index. We also show how the basic methodology can be altered to derive a revenue equivalent uniform tax, which measures the tax burden implied by the public sector. A numerical example is used to illustrate the method developed, and extensions of the analysis to handle models with multiple households and nonlinear taxation structures are undertaken.     

Optimal social security tax with myopic agents

Myopic agents lack the foresight to save for their own old age. It is generally believed that correcting myopia is a rationale for a pay-as-you-go (PAYG) pension system. This view has been supported by existing literature showing that the optimal PAYG social security tax should increase when people are more myopic. In this paper we obtain new results opposed to the traditional view. By establishing a very standard general equilibrium OLG model with myopic agents and endogenized marginal product of capital, we show that the optimal social security tax should be lower when people are more myopic. Our numerical analysis also shows that the welfare cost of the social security tax increases with people's degree of myopia. These results suggest that correcting myopia is not a clear rationale for the PAYG social security.     

Striking a balance: Optimal tax policy with labor market duality

We develop a dynamic general equilibrium model where employers may avoid making social security contributions by offering some workers “secondary contracts.” When calibrated using aggregate tax revenue data, the model delivers estimates of secondary “off the books” employment that are consistent with survey evidence for the EU14 and United States. We investigate the fiscal and welfare effects of varying the avoidable and unavoidable shares of labor income tax while keeping the total wedge constant, and find that increasing the employer component raises hours worked, output, and welfare. Partial labor tax evasion makes tax revenues more elastic, but full tax compliance need not be a welfare enhancing policy mix.     

Optimal tax reform in the presence of adjustment costs

The optimal implementation of an efficiency-enhancing capital taxation reform is examined when the government is concerned about arbitrary reform-induced redistributions and investment causes firms to incur adjustment costs. Theoretical results indicate that immediate partial enactment of reform is optimal with concave adjustment costs, while with convex adjustment costs, the optimal reform implementation policy is either (i) immediate partial enactment with sufficiently low adjustment costs, (ii) phased-in partial enactment with intermediate adjustment costs, or (iii) postponed partial enactment with sufficiently high adjustment costs. Numerical results suggest that, relative to the optimal one-step implementation policy, little is gained by phasing-in reform.     

Corporate tax competition: A meta-analysis

Do jurisdictions compete over corporate taxes? The extent of uncooperative strategic government interactions in corporate tax policy remains unclear, because the results reported in relevant econometric studies vary considerably. This paper applies meta-analysis and meta-regression methods to a novel dataset consisting of 604 observations on corporate tax competition reported in 33 primary studies. The results point to the presence of corporate tax competition effects, and there is no consistent evidence for publication selection bias. The analysis, however, reveals that several data and specification choices systematically affect the results reported in the literature: the choice of the weighting scheme applied in estimating the corporate tax function and details of the econometric estimation strategy are significant when it comes to explaining variation in reported results. Furthermore, we find that accounting for partisan politics and country size matters.     

Optimal tax policy and foreign direct investment under ambiguity

We analyze the optimal timing of an irreversible foreign direct investment by a foreign firm and the optimal tax policy by a host country under ambiguity. We derive the optimal GDP level at which the foreign firm switches from exporting to a foreign direct investment. Furthermore, we derive the optimal tax policy by the host country, and analyze the effect of an increase in ambiguity on the optimal tax policy. We show that the host country should reduce the optimal corporate tax rate from the host government’s perspective in response to an increase in ambiguity. Our result is different from the one obtained by Pennings (2005) that shows that an increase in risk induces an increase in the optimal corporate tax rate.     

A tax discrepancy coefficient resulting from tax evasion or tax expenditures

Tax evasion and tax expenditures introduce discrepancies between taxpayers. In this paper, a tax discrepancy coefficient has been worked out in order to establish, given a constant tax yield, what bigger or smaller amounts taxpayers would have to pay if tax evasion or tax expenditures were completely eliminated. After the definition of the coefficients these are calculated for individual income tax returns in Belgium. Similar coefficients can be established for other types of taxation, such as inheritance tax, corporate income tax or even sales tax (e.g. V.A.T.).     

Optimal indirect taxation with a restricted number of tax rates

This paper analyzes the optimal structure of indirect taxation when the number of available tax rates is smaller than the number of taxable commodities. Such a constraint requires to choose the levels of tax rates and the groups of commodities that will be taxed at equal rates (or exempted). In a partial equilibrium framework, with a single agent and a low amount of tax collection, it is shown that the process of allocation of commodities to groups depends on both price elasticities and consumption spendings. Still, the optimal tax structure displays a weak form of the inverse elasticity rule; consumption spendings influence the size of the fiscal base, and may lead to many tax exemptions.     

Optimal income taxation with tax avoidance and endogenous labour supply

I determine the optimal income tax schedule when individuals both choose endogenously their labour supply and have the possibility of avoiding paying taxes. Considering a convex concealment cost function, I propose a formula for the optimal marginal tax rate, that generalizes the formula of the standard Mirrlees model to the case of tax avoidance. I also show that the results obtained by Casamatta (2021) in the fixed income case hold true when labour supply is endogenous: with a low enough marginal cost of avoidance, it is optimal to let some taxpayers, located in the interior of the skill distribution, avoid taxes.     

Optimal top marginal tax rates under income splitting for couples

This paper provides formulas for optimal top marginal tax rates when couples are taxed according to income splitting between spouses, consumption is taxed, and the skill distribution is unbounded. Optimal top marginal income tax rates are computed for Germany using a dataset that includes the tax returns of all German top taxpayers. We find that the optimal top marginal tax rate converges to about 2/3 and convergence obtains at income levels that are substantially higher than those currently subject to the actual top tax rate.