Dynamic Optimal Taxation with Private Information

We study dynamic optimal taxation in a class of economies with private information. Optimal allocations in these environments are complicated and history-dependent. Yet, we show that they can be implemented as competitive equilibria in market economies supplemented with simple tax systems. The market structure in these economies is similar to that in Bewley (1986) ; agents supply labour and trade risk-free claims to future consumption, subject to a budget constraint and a debt limit. Optimal taxes are conditioned only on two observable characteristics—an agent's accumulated stock of claims, or wealth, and her current labour income. We show that optimal taxes are generally non-linear and non-separable in these variables and relate the structure of marginal wealth and income taxation to the properties of agent preferences.     

Optimal Design of Forest Taxation with Multiple-Use Characteristics of Forest Stands

The paper studies optimal forest taxation under uncertainty about future timber price when private forest owners value amenity services of forest stands and forest stands have public goods characteristics. It is assumed that preferences of forest owners can be described by a quasi-linear, intertemporal utility function which reflects risk aversion in terms of consumption and constant marginal utility in terms of amenity services. The comparative statics of current and future harvesting in terms of timber price risk, site productivity tax and yield tax are first developed. It is shown that, given the optimal site productivity tax, which is independent of the timber harvested and thus non-distortionary, it is desirable to introduce the yield tax at the margin; it both corrects externality due to the public goods characteristic of forest stands and serves as a social insurance device. The optimal yield tax is less than 100% and depends on the social value of forest stands, timber price risk and properties of compensated timber supply. In the general case the 'inverse elasticity rule – according to which the optimal yield tax is negatively related to the size of the substitution effects – may not hold. Under certainty, the desirability of the yield tax, given the optimal site productivity tax, depends only on the existence of public goods characteristic and is thus a pure Pigouvian tax.     

Optimal taxation over the life cycle

We derive the optimal labor income tax schedule for a life cycle model with deterministic productivity variation and complete asset markets. An individual chooses whether and how much to work at each date. The government must finance a given expenditure and does not have access to lump sum taxation. We develop a solution method that uses the primal approach to solve for the optimal non-linear tax function. The average tax rate determines when an individual will work while the marginal tax rate determines how much she will work. Even in the absence of redistributive concerns, the optimal tax schedule has an increasing average tax rate at low levels of income to encourage labor market participation. The marginal tax rate at the top is strictly positive. Finally, the model is used to assess the effects of changing the current tax schedule to the optimal one. Under the preferred parameters, this delivers a welfare gain equivalent to 0.67 percent of lifetime consumption.     

The Optimal Asymptotic Income Tax Rate

This paper shows that a policy maker needs only two types of information to set the optimal income tax rate at the top: a measure of labor supply elasticity and the shape of skills distribution. We find that the asymptotic tax rate is not affected by the degree of inequality aversion as long as the marginal utility of consumption converges to zero. By using empirically plausible estimates for the compensated labor supply elasticity and the shape of skills distribution, we find that the optimal marginal tax rate at the top should be between 33% and 60%, which is in line with the existing rates in the real world.     

The Optimal Linear Income Tax Model: Utility or Equivalent Income?

This paper compares the use of equivalent income with that of utility, in the social welfare function, in optimal income tax models. Equivalent income is a money metric welfare measure that, unlike utility, is not affected by monotonic transformations of utility. The use of equivalent income is found to produce an optimal tax rate that is more sensitive to the degree of inequality aversion, compared with the use of utility. With Cobb-Douglas and CES utility functions, the optimal tax rate is the same for utility and equivalent income where relative inequality aversion is unity. When using equivalent incomes, the case for high marginal rates does not depend on the assumption of a very low elasticity of substitution between consumption and leisure.     

Price and quantity regulation in general equilibrium

We consider a general equilibrium model with a production externality (e.g. pollution), where the regulator does not observe firm productivity shocks. We examine quantity (permit) regulation and price (tax) regulation. The quantity of permits issued by the regulator are independent of the productivity shock, since shocks are unobserved. Price regulation implies use of the regulated input is an increasing function of the productivity shock because firms take advantage of a good productivity shock by increasing input use. Thus price regulation generates higher average, but more variable, production. Therefore, we show that in general equilibrium the relative advantage of quantity versus price regulation depends not only on the slopes of marginal benefits and costs, but on general equilibrium effects such as risk aversion. The general equilibrium effects are often more important than the slopes of the marginal benefits and cost curves. In the simplest model, a reasonable risk aversion coefficient implies quantity regulation generates higher welfare regardless of the benefit function.     

Inequality aversion in post-communist countries in the years of the crisis

This article provides estimates for the parameters of inequality aversion for 10 post-communist economies of central and eastern Europe in the years of the crisis. To this aim, we employ the information on the level of tax progressivity available in the European Union Survey on Income and Living Conditions cross-sectional microdata, under the assumption that the principle of equal sacrifice drives the choices of governments on marginal tax rates. Results reveal a remarkable variety of preferences for redistribution across the countries during the time period considered (2008–2012), with some of them converging towards the generally higher inequality aversion levels of the western European Union, perhaps as a result of policy responses to the crisis.     

The optimal linear income tax: A diagrammatic analysis

This paper clarifies the role of the tax possibility frontier and the social indifference curve in the comparative statics analysis of the optimal linear income tax. By a mostly diagrammatic derivation of the results we confirm the conventional conjecture that the optimal marginal tax rate increases with the government's inequality aversion. On the other hand, we cannot always confirm analytically the conventional conjecture that the optimal marginal tax rate increases with the government's budgetary needs.     

Optimal income taxation with human capital accumulation and limited record keeping

This paper characterizes optimal income taxes in a dynamic economy where human capital is unobservable and the government is restricted to use taxes that depend only on current income. I show that unobservability of human capital tends to decrease the labor wedge, while the effect on the human capital wedge is uncertain. I also analyze the relationship between optimal taxes in economies with and without endogenous human capital and identify two qualitative reasons why the optimal tax codes will differ. I perform numerical simulations to calculate the quantitative relevance of endogenous human capital formation for optimal tax policy. I find that endogenous human capital lowers marginal tax rates by about 9% on average, as compared with a static model without human capital.     

On the Optimality of Search Matching Equilibrium When Workers Are Risk Averse

This paper revisits the normative properties of search‐matching economies when homogeneous workers have concave utility functions and wages are bargained over. The optimal allocation of resources is characterized first when information is perfect and second when search effort is not observable. In the former case, employees should be unable to extract a rent. The optimal marginal tax rate is then 100%. As search effort becomes unobservable, an appropriate positive rent is needed and the optimal marginal tax rate is lower. Moreover, the pretax wage is lower in order to boost labor demand. Finally, in both cases, nonlinear income taxation is a key complement to unemployment insurance.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

Self-selection and Pareto efficient taxation

This paper analyses the set of Pareto efficient tax structures. The formulation of the problem as one of self-selection not only shows more clearly the similarity between this problem and a number of other problems (such as the optimal pricing of a monopolist) which have recently been the subject of extensive research, but also allows the derivation of a number of new results. We establish (i) under fairly weak conditions, randomization of tax structures is desirable; (ii) if different individuals are not perfect substitutes for one another in production, then the general equilibrium effects—until now largely ignored in the literature—of changes in the tax structure may be dominant in determining the optimal tax structure; in particular if the relative wage of high ability and low ability individuals depends on the relative supplies of labor, the optimal tax structure entails a negative marginal tax rate on the high ability individuals, and a positive marginal tax rate on the low ability individuals (the marnitude of which depends on the elasticity of substitution); (iii) if individuals differ in their preferences, Pareto efficient taxation may entail negative marginal tax rates for high incomes; while (iv) if wage income is stochastic, the marginal tax rate at the upper end may be 100%.Our analysis thus makes clear that the main qualitative properties of the optimal tax structure to which earlier studies called attention are not robust to these attempts to make the theory more realistic.     

Does a Recession Call for Less Stringent Environmental Policy? A Partial-Equilibrium Second-Best Analysis

This paper analyses second-best optimal environmental policy responses to real and financial shocks in a two-period partial equilibrium model with heterogeneous firms, an environmental externality, and credit constraints. We show that, to alleviate credit constraints and encourage investment, the second-best optimal emission tax falls short of marginal emission damages. The optimal response to shocks depends on how the shock affects the size of the environmental and credit market failures and the effectiveness of the tax in alleviating these market failures. Under mildly restrictive assumptions on functional forms, the optimal response to a (persistent) negative productivity shock or a tightening of credit is to reduce the emission tax. Our results are informative for how climate change policy should optimally change with the business cycle.     

Optimal income tax under the threat of migration by top-income earners

We examine how allowing individuals to emigrate to pay lower taxes changes the optimal nonlinear income tax scheme in a Mirrleesian economy. An individual emigrates if his domestic utility is less than his utility abroad, net of migration costs — utilities and costs both depending on productivity. A simple formula, that complements Saez's formula obtained in closed economy, is derived for the marginal tax rates faced by top-income earners. It depends on the labour elasticity, the tax rate abroad and the migration costs expressed as a fraction of the utility obtained abroad. The Rawlsian marginal tax rates, obtained for the whole population, illustrate a curse of the middle-skilled. Simulations are provided for the French economy.     

Growth and Welfare Effects of Tax Cuts: The Case of a Productive Public Input with Technological Risk

This paper analyzes the dynamic impact of tax cuts within a stochastic model of endogenous growth with a congested public input. A decreasing taxation of deterministic income parts leads to the well-known positive growth effect. Nevertheless, due to the insurance effect associated with the taxation of stochastic income flows, the overall growth impact of taxation is ambiguous. It is shown that the optimal structure of financing government expenditure does not only depend on the degree of rivalry but also on the degree of risk aversion. The optimal real value of government debt decreases with a rise in congestion. We identify that in the case of proportional congestion, the base for tax cuts should be the growth neutral consumption tax. Maximizing the growth rate does not automatically coincide with maximizing welfare. Hence, the base for tax cuts gains importance to realize a welfare optimal policy.     

FDI,taxes and agglomeration economies in the EU15

This article provides an empirical analysis of the impact of tax differentials and agglomeration economies on Foreign Direct Investment (FDI). The article departs from most previous work on FDI and tax competition in a number of ways. First, it incorporates several measures of agglomeration in order to investigate whether agglomeration economies mitigate the downward spiral in tax rates. As the strength of agglomeration economies may vary with the degree of integration, we use a panel of bilateral FDI flows for a highly integrated region including countries with similar economic structure – the EU15 – from 1986 to 2004. Second, the empirical analysis explicitly deals with the problem of selection bias by using the Heckman sample selection approach. Also, by focusing on the EU15, we are able to provide additional information on the determinants of FDI between similar, higher-income countries. The empirical analysis provides some evidence of corporate marginal effective tax rates having an impact on FDI. This result, however, is sensitive to the inclusion of agglomeration economies. In particular, we find both Marshall types of technological externalities and overall concentration of economic activity to have an influence on FDI flows and, moreover, mitigating the negative impact of taxes.     

On Environmental Taxation under Uncertain Environmental Damage

This paper addresses optimal taxation, when therelationship between the consumption of a`dirty' good and the resulting environmentaldamage is uncertain and treated as a randomvariable by policy makers. The main purpose isto analyze how increased uncertainty, measuredas a mean preserving increase in the spread ofthis random variable, affects the optimalcommodity tax on the dirty consumption good. Incase the only task of government is to correctthe environmental externality, and if thepreferences are characterized by nondecreasingabsolute risk aversion, we find that thecommodity tax on the dirty consumption goodincreases in response to additionaluncertainty. If, on the other hand, thegovernment provides a public good and uses alump-sum tax in addition to the commodity tax,it is possible that the commodity tax decreasesas a response to additional uncertainty, evenif the preferences are characterized bynondecreasing absolute risk aversion. A similarresult emerges, although for different reasons,if the lump-sum tax is replaced by a laborincome tax.     

Stochastic growth with short-run prediction of shocks

We study a variation of the one-sector stochastic optimal growth model with independent and identically distributed shocks where agents acquire information that enables them to accurately predict the next period??s productivity shock (but not shocks in later periods). Optimal policy depends on the forthcoming shock. A ??better?? predicted realization of the shock that increases both marginal and total product always increases next period??s optimal output. We derive conditions on the degree of relative risk aversion and the elasticity of marginal product under which optimal investment increases or decreases with a better shock. Under fairly regular restrictions, optimal outputs converge in distribution to a unique invariant distribution whose support is bounded away from zero. We derive explicit solutions to the optimal policy for three well-known families of production and utility functions and use these to show that volatility of output, sensitivity of output to shocks, and expected total investment may be higher or lower than in the standard model where no new information is acquired over time; the limiting steady state may also differ significantly from that in the standard model.     

Environmental Tax in a Green Market

We examine the impact of an emission tax in a green market characterized by consumers’ environmental awareness and competition between firms for both environmental quality and product prices. The unique aspect of this model comes from the assumption that the cost for an increase in quality is fixed. We show that the emission tax improves welfare, thanks to a decline in pollution and despite an accentuation of product differentiation. The higher the marginal environmental damage is, the higher the optimal tax will be. The optimal tax, however, becomes lower than the marginal damage when the market is not too large. Finally, when marginal environmental damage is not too low, the optimal tax leads to a green product monopoly.     

The Optimal Provision of Curative Goods

We analyze the optimal contract between a risk neutral regulator providing a curative goods and a risk averse patient who learns the realized value of his/her health status after the contracting stage. Consumption of a curative good (healthcare) reduces the disutility associated with a disease. We show that the consumption of curative goods is larger than in the complete information case, that this overprovision increases with the degree of patients’ risk‐aversion and the marginal cost of treatment. Ceilings on the amount of healthcare are part of the optimal contract when risk aversion is important.