Optimal linear income taxation with partial information

This letter presents a preliminary analysis of a tax problem whereby the tax function can depend not only on income but also on variables which are correlated with ‘earning ability’ and are known to the government. Our main result suggests that the tax system improved through increased use of such variables, and the optimal tax rate becomes larger.     

Inequality-growth nexus under progressive income taxation

Within heterogeneous-household extensions of Romer’s (1986) one-sector representative agent model of endogenous growth, this paper finds that changes made to the U.S. statutory income tax in the past decades account for a substantial portion of the following stylized facts: (i) U.S. income inequality significantly deteriorates since the mid-1980s; (ii) the inequality-growth nexus displays a positive slope before and after the implementation of the Tax Reform Act of 1986 (TRA-86); and (iii) the slope of the inequality-growth nexus sharply declines between the pre- and post-TRA-86-reform periods, indicating less deterioration in real GDP per capita growth when pursuing a more equal income distribution after 1986. In addition to income inequality, the responses of several other measurements of inequality to changes in the tax code parameters are also explored.     

Optimal marginal and average income taxation under maximin

Using the Mirrlees optimal income tax model under maximin, we derive fairly mild conditions for a decreasing marginal tax rate throughout the skill distribution with no bunching, a strictly concave tax function in income and a single-peaked average tax schedule. Assuming additive preferences and an isoelastic disutility of labor function, these tax profiles are implied by aggregate skills that are non-decreasing with the skill level. If preferences are quasilinear in leisure or in consumption, these tax profiles are also obtained under a large set of skill distributions.     

Voting over income taxation

A major problem of the positive theory of income taxation is to explain why statutory income tax schedules in practice are marginal-rate progressive. While it is commonly believed that this is but a simple consequence of the fact that the number of relatively poor voters exceeds that of richer voters in general, putting this contention in a voting equilibrium context is not a trivial task. We do this here in the context of nonlinear taxation and attempt to provide a formal argument in support of this heuristic claim. We first establish the existence of mixed strategy equilibria and identify certain cases in which marginal-rate progressive taxes are chosen almost surely by the political parties. Unfortunately, we also find that if the tax policy space is not artificially constrained, the support of at least one equilibrium cannot be contained within the set of marginal-rate progressive taxes.     

The undesirability of randomized income taxation under decreasing risk aversion

For the standard specification of the utilitarian optimal income tax problem with hidden characteristics, the paper shows that randomized tax schemes are undesirable if preferences exhibit a property of weakly decreasing risk aversion according to the multidimensional risk aversion concept of Hellwig [Hellwig, M.F., 2004, Risk Aversion in the Small and the Large with Multidimensional Outcomes. Max Planck Institute for Research on Collective Goods, Bonn. Preprint 2004/6, http://www.mpp-rdg.mpg.de/pdf_dat/2005_23online.pdf]. This property of decreasing risk aversion also implies that the optimal income tax schedule is unique and depends continuously on the data of the problem.     

A note on corporate taxation,limited liability,and asymmetric information

Becker and Fuest (this issue, p. 1–10) provides a new explanation for the link between limited liability and corporate taxation. The authors argue that a corporate tax on all entrepreneurs with limited liability is optimal when entrepreneurs can offset potential losses and when asymmetric information exists regarding projects’ qualities. This note considers a model with a slightly modified production technology. It confirms that entrepreneurs’ abilities to offset losses and the existence of asymmetric information may affect government policy. However, it also shows that the optimal taxation policy differs from that suggested by Becker and Fuest.      

Public investment criteria under optimal nonlinear income taxation without commitment

In this study, we highlight that the incredibility of the government's commitment to a certain tax policy is a determinant of production inefficiency. We show that if the government cannot commit to a certain tax policy and if the types of taxpayers are completely separated, then the production efficiency theorem could be violated in an optimal solution. In this case, an incremental unit of public or private capital affects taxpayers' labor supply through wage rates. In a situation where public capital is more (less) complementary to labor than private capital, public investment tightens (relaxes) the incentive compatibility constraint more than private investment.     

Optimum income taxation and layoff taxes

This paper analyzes optimum income taxation in a model with endogenous job destruction that gives rise to unemployment. It is shown that optimal tax schemes comprise both payroll and layoff taxes when the state provides public unemployment insurance and aims at redistributing income. The optimal layoff tax is equal to the social cost of job destruction, which amounts to the sum of unemployment benefits (that the state pays to unemployed workers) and payroll taxes (that the state does not get when workers are unemployed).     

Capital income taxation and perfect foresight

This paper develops a perfect foresight model of capital income taxation in a representative household neoclassical one-sector framework. The household sector is based on intertemporal utility maximization. The main result is the equivalence of a perfect foresight solution and an artificial central planning solution; if there is no tax, this is the equivalence of a market equilibrium and social optinum. The equivalence result is used to deduce the implications of a partial tax reform policy. It is shown that a partial reform increases capital at each time following the initial period of the program.     

Investment subsidies and redistributive capital income taxation in a neoclassical growth model

How do investment subsidies bear on pure redistribution when coupled with capital income taxes? In a heterogeneous agent, neoclassical growth framework it is found that on impact, with no optimizing behavior, investment subsidies are good for growth but bad for redistribution. The opposite holds for capital income taxes. But when the government acts as a Stackelberg leader vis-à-vis the private sector (the follower), the optimal feedback policy is by construction time-consistent and implies that in a long-run optimum the tax scheme does not distort accumulation. This holds regardless of social preferences. For the feedback Stackelberg equilibrium I find that (pure) redistribution can go either way and capital income taxes are nonzero in the long-run, time-consistent optimum, depending on the social weight of those who receive redistributive transfers, the distribution of pretax factor incomes, and the intertemporal elasticity of substitution. It is argued that investment subsidies may be an important indirect tool for redistribution, and may allow for the separation of “efficiency” and “equity” concerns.     

Differential income taxation and household asset allocation

This article empirically investigates the effects of differential income taxation on households’ portfolio choice and asset allocation, applying a two-stage budgeting model of asset demand to German survey data. The model is structured into the discrete and the continuous asset choice. Cross-sectional variation in marginal tax rates, appropriately instrumented, as well as over-time variation from a major tax reform are used to identify the tax effects. Households with higher tax rates are found to have relatively greater demand for tax-privileged assets, such as nonowner-occupied housing, mortgage repayments, building society deposits, stocks, insurances and consumer credits, than households with lower tax rates. Demand at higher tax rates is lower for owner-occupied housing, bank deposits and bonds.     

Public health insurance and optimal income taxation

If individuals differ not only in their inherent capacity to earn income, but also in the probability that they will fall ill, can subsidized public health insurance be justified on the grounds that it serves as an efficient tool to redistribute welfare? This question is analyzed in a model where the social welfare function is a weighted average of individual expected utilities, and where taxation is by a linear income tax. The answer is ‘yes’, except in certain special cases.     

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.     

Stackelberg leadership under symmetric and asymmetric information

This Paper considers the types of pre-committments that a first moving incumbent may make when information is symmetric, and when it is asymmetric. The model contains as a special case the familiar model of Stackelberg leadership, but also shows the circumstances under which more complex strategies are optimal for the incumbent.     

Production and financial policies under asymmetric information

We propose an extension of the standard general equilibrium model with production and incomplete markets to situations in which (i) private investors have limited information on the returns of specific assets, (ii) managers of firms have limited information on the preferences of individual shareholders. The extension is obtained by the assumption that firms are not traded directly but grouped into ‘sectorial’ funds. In our model the financial policy of the firm is not irrelevant. We establish the existence of equilibria and discuss the nature of the inefficiencies introduced by the presence of asymmetric information. We also illustrate the properties of the model in three simple examples. We would like to thank Alberto Bisin, Armando Dominioni, Piero Gottardi, Tito Pietra, Paolo Siconolfi, and an anonymous referee for useful suggestions and comments.     

An alternative approach to income taxation

We take an alternative approach to income taxation in this paper. We view the income tax schedule as the outcome of a voting process, rather than the optimal choice of a “benevolent social planner”. We show that it is very likely for majority voting to lead to the adoption of a regressive income tax schedule, depending on the per capita government revenue requirement and the mean productivity of the population, which is in sharp contrast with the result derived from the traditional “benevolent social planner” approach to income taxation; and that given the adoption of a regressive income tax schedule, the income tax schedule would become less regressive as the ratio of the per capita government revenue requirement over the mean productivity of the population increases. Our work might shed some light on both the prevalent adoption of regressive state tax systems and the cross-state difference in terms of tax systems.     

Optimal nonlinear income taxation with learning-by-doing

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates generally no longer apply. In particular, if the government cannot commit and each consumer's skill-type is revealed, it is optimal to distort the high-skill type's labour supply downwards through a positive marginal tax rate to relax an incentive-compatibility constraint. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on both labour supply and wages.     

Learning about compliance under asymmetric information

Over time, inspection agencies gather information about firms’ pollution levels and this information may allow agencies to differentiate their monitoring strategies in the future. If a firm is less successful than its peers in reducing emissions, it faces the risk of being targeted for increased inspections in the next period. This risk of stricter monitoring might induce high-abatement cost firms to mimic low-abatement cost firms by choosing lower emission levels, while the latter might try to avoid being mimicked. We explain firms’ compliance decisions and the inspection agency's monitoring strategy by means of a signaling game which incorporates dynamic enforcement and learning. Interestingly, we show that the ongoing signaling game between firm types might lead to firms over-complying with the emission standard.