Optimal redistributive taxation with both extensive and intensive responses

We study optimal income taxation when labor supply reacts along the intensive and extensive margins. Individuals are heterogeneous across two unobserved dimensions: their skill and disutility of participation. We develop a new method to analytically derive conditions under which optimal marginal tax rates are non-negative everywhere. It is typically optimal to provide a distinct level of transfer to the non-employed and to workers with negligible earnings. Numerical simulations illustrate these properties for the US. We also apply our method to sign output distortions in other adverse selection frameworks with random participation, namely the monopoly nonlinear pricing and the regulatory monopoly problems.     

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.     

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.     

Optimal nonlinear income taxation with a finite population

In the standard optimal income taxation problem, tax payments depend only on each consumer's own actions. Piketty [J. Econ. Theory 61 (1993) 23-41] shows that, if one individual's tax schedule depends on others’ actions and the government knows the exact ability distribution, it can implement any undistorted allocation as the unique revelation game outcome. If some individuals misreveal their types, Piketty's mechanism may assign infeasible allocations. We require that tax schedules must balance the government budget for every possible vector of revelations. When individuals reveal their type by simple announcements, all undistorted allocations can be still implemented, even with off-equilibrium feasibility constraints.     

On indirect taxation and weakly basic commodities

I am most grateful to Christian Bidard, Wilfried Parys, Jean Cartelier, Gianni Vaggi and the anonymous referees of this Journal for their comments on previous drafts of the paper. All remaining errors are mine.     

Corporate taxation, debt financing and foreign-plant ownership

This paper compares domestically and foreign-owned plants with respect to their debt-to-assets ratio and analyzes to which extent the difference is systematically affected by corporate taxation. To derive hypotheses about influence of corporate taxation on a firm's debt financing we adapt a standard model of taxation and financing decisions of firms for the case of international debt shifting activities of foreign-owned firms. We estimate the average difference between a foreign-owned and a domestically owned firm's debt ratio, treating the mode of ownership as endogenous. Using data from 32,067 European firms, we find that foreign-owned firms on average exhibit a significantly higher debt ratio than their domestically owned counterparts in the host country. Moreover, this gap in the debt ratio increases with the host country's statutory corporate tax rate.     

Dynamic inconsistency and non-preferential taxation of foreign capital

When capital is sunk after it is invested, a host government facing heterogeneous foreign investors has a strong incentive to reduce preferential taxes over time in order to attract less eager investors while fully expropriating past investors. This induces investors to wait rather than invest in the initial period, and leads to loss of tax revenue. This dynamic inconsistency problem is resolved if the host government commits to non-preferential taxation in each period even if it does not commit to future tax rates.     

Foreign (in)direct investment and corporate taxation

Abstract Foreign investments of multinational firms are often complex in that they involve conduit entities. In particular, a multinational can pursue either a direct or an indirect investment strategy, where the latter involves an intermediate corporate entity and is associated with enhanced opportunities for international tax planning. As a consequence, in the case of indirect investments, the role of corporate taxation in destination countries may change. This paper investigates the effects of corporate taxation on foreign investment decisions of German multinationals, taking explicitly into account that firms choose in a first stage the investment regime (direct vs. indirect). The empirical findings, consistent with theoretical predictions, suggest that tax effects differ according to whether the investment is direct or indirect.     

Optimal nonlinear income taxation with productive government expenditure

This paper develops an endogenous growth model with a production externality and nonlinear income taxation, and uses it to examine how the fiscal authority devises its nonlinear tax structure from the viewpoint of welfare maximization. It is found that, in the Barro (1990) model, Pareto optimality can be achieved if both policy instruments for the tax scalar and the extent of the tax progressivity/regressivity are set optimally.     

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.     

Redistributive taxation with heterogeneous relative consumption concerns

Abstract This paper studies the impact of redistributive income taxation in a society where only some individuals are motivated by relative consumption concerns. Introducing this heterogeneity raises theoretical challenges since (i) earned income becomes an imperfect indicator of underlying ability and (ii) relative concerns may be inadmissable in the social objective. A new behavioural model is developed in which only relatively‐concerned individuals choose work effort strategically. Linear tax/transfer systems schemes are then characterized and simulated for a series of welfarist and non‐welfarist social objectives, and for different degrees of preference heterogeneity. A key result is that a government which understands the extent of relative consumption concerns–but places no social weight on individuals with such preferences–nevertheless sets a significantly more progressive tax system than a government which ignores relative consumption motivations altogether.     

Redistributive politics with distortionary taxation

This paper proposes a first step towards a positive theory of tax instruments. We present a model of redistributive politics that extends those of Myerson [R. Myerson, Incentives to cultivate minorities under alternative electoral systems, Amer. Polit. Sci. Rev. 87 (1993) 856-869] and Lizzeri and Persico [A. Lizzeri, N. Persico, The provision of public goods under alternative electoral incentives, Amer. Econ. Rev. 91 (2001) 225-239]. Two politicians compete in terms of targeted redistributive promises financed through distortionary taxes. We solve for the case of both targetable and non-targetable taxes. We prove that there is an imperfect efficiency-targetability trade off on the tax side. Politicians prefer targetable taxes over non-targetable ones, especially when the latter are less efficient. Yet, targetable taxation is always used even when it is very inefficient compared to non-targetable taxes.     

Social security, retirement age and optimal income taxation

It is often argued that implicit taxation on continued activity of elderly workers is responsible for the widely observed trend towards early retirement. In a world of laissez-faire or of first-best efficiency, there would be no such implicit taxation. The point of this paper is that, when first-best redistributive instruments are not available, because some variables are not observable, the optimal policy does imply a distortion of the retirement decision. Consequently, the inducement of early retirement may be part of the optimal tax-transfer policy. We consider a model in which individuals differ in their productivity and their capacity to work long and choose both their weekly labor supply and their age of retirement. We characterize the optimal non-linear tax-transfer that maximizes a utilitarian welfare function when weekly earnings and the length of active life are observable while individuals' productivity and health status are not observable.     

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.     

The limitations of decentralized world redistribution: An optimal taxation approach

A centralized scheme of world redistribution that maximizes a border-neutral social welfare function, subject to the disincentive effects it would create, generates a drastic reduction in world consumption inequality, dropping the Gini coefficient from 0.69 to 0.25. In contrast, an optimal decentralized (i.e., with no cross-country transfers) redistribution has a miniscule effect on world income inequality. Thus, the traditional public finance concern about the excess burden of redistribution cannot explain why there is so little world redistribution.Actual foreign aid is vastly lower than the transfers under the simulated world income tax, suggesting that voluntary world transfers - subject to a free-rider problem - produces an outcome that is consistent with rich countries such as the United States either placing a much lower value on the welfare of foreigners, or else expecting that a very significant fraction of cross-border transfers is wasted. The product of the welfare weight and one minus the share of transfers that are wasted constitutes the implicit weight that the United States assigns to foreigners. We calculate that value to be as low as 1/2000 of the value put on the welfare of an American, suggesting that U.S. policy is consistent with social preferences that place essentially no value on the welfare of the citizens of the poorest countries, or that implicitly assumes that essentially all transfers are wasted.     

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.     

International corporate taxation and U.S. multinationals' behaviour: an integrated approach

Abstract .  This paper explores the effects of corporate taxation on U.S. capital invested abroad and on tax planning practices. The econometric analysis first indicates that investment is strongly influenced by average tax rates, with a magnified impact particularly for low-tax rates, implying that the attractiveness of low-tax countries is not weakened by anti-deferral rules and cross-crediting limitations. Further explorations suggest that firms report higher profit, higher Subpart F income, and are less likely to repatriate dividends when they are located in low-tax jurisdictions. Finally, when the role of effective transfer pricing regulations is estimated, it appears that low degrees of law enforcement are associated with higher income shifting.     

The public and private provision of pure public goods and the distortionary effects of income taxation: a political economy approach

Abstract .  A pure public good is provided by the government and the voluntary contributions of two types of households. The government finances its contribution by means of income taxation. The latter has distortionary effects. A third type of household never makes contributions. We analyse the effects of changes in the income tax rate on (a) the provision of the public good, (b) the private contributions of the households, and (c) changes in the distribution of income and welfare between contributing and non-contributing households. We derive a simple and testable condition under which the lowering of the income tax entails a Pareto improvement.     

Income segregation and local progressive taxation: Empirical evidence from Switzerland

This study investigates spatial income segregation in fiscally decentralized urban areas. The theoretical part proposes the progressivity of local income taxes as a new theoretical explanation for income segregation. The empirical part studies how income tax differentials across municipalities affect the households' location decisions. I use data from the Swiss metropolitan area of Basel that contains tax information on all moving households in 1997. The location choice of the households is investigated within the framework of the random utility maximization model. Different econometric specifications of the error term structure, such as conditional logit, nested logit and multinomial probit, are compared. The empirical results show that rich households are significantly and substantially more likely to move to low-tax municipalities than poor households. This result holds after controlling for alternative explanations of segregation. Social interactions and distance from the central business district are established as other major factors for income segregation. Households in general tend to choose locations close to other households like themselves.