nep-pub New Economics Papers
on Public Finance
Issue of 2007‒02‒10
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Risky human capital and deferred capital income taxation By Borys Grochulski; Tomasz Piskorski
  2. Taxing Capital? Not a Bad Idea After All! By Juan Carlos Conesa; Sagiri Kitao; Dirk Krueger
  3. The Excess Burden of Government Indecision By Francisco J. Gomes; Laurence J. Kotlikoff; Luis M. Viceira
  4. On the Rationale for the Use of Border Taxes in Developing Countries By Knud Jørgen Munk
  5. Rules of Normalisation and their Importance for Interpretation of Systems of Optimal Taxation By Knud Jørgen Munk
  6. Tax-tariff reform with costs of tax administration By Knud Jørgen Munk
  8. Taxation and Market Work: Is Scandinavia an Outlier? By Richard Rogerson

  1. By: Borys Grochulski; Tomasz Piskorski
    Abstract: We study the structure of optimal wedges and capital taxes in a Mirrlees economy with endogenous skills. Human capital is a private state variable that drives the skill process of each individual. Building on the findings of the labor literature, we assume that human capital investment is a) risky, b) made early in the life-cycle, and c) hard to distinguish from consumption. These assumptions lead to the optimality of a) a human capital premium, i.e., an excess return on human capital relative to physical capital, b) a large intertemporal wedge early in the life-cycle stemming from the lack of Rogerson's [Econometrica, 1985] "inverse Euler" characterization of the optimal consumption process, and c) an intra-temporal distortion of the effort/consumption margin even at the top of the skill distribution at all dates except the terminal date. The main implication for the structure of linear capital taxes is the necessity of deferred taxation of physical capital. In particular, deferred taxation of capital prevents the agents from making a joint deviation of under-investing in human capital ex ante and shirking from labor effort at some future date in the life-cycle, as the marginal deferred tax rate on physical capital held early in the life-cycle is history-dependent. The average marginal tax rate on physical capital held in every period is zero in present value. Thus, as in Kocherlakota [Econometrica, 2005], the government revenue from capital taxation is zero. However, since a portion of the capital tax must be deferred, expected capital tax payments cannot be zero in every period. Necessarily, agents face negative expected capital tax payments due early in the life-cycle and positive expected capital tax payments late in the life-cycle. Also, relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile
    Keywords: Taxation
    Date: 2007
  2. By: Juan Carlos Conesa; Sagiri Kitao; Dirk Krueger
    Abstract: In this paper we quantitatively characterize the optimal capital and labor income tax in an overlapping generations model with idiosyncratic, uninsurable income shocks, where households also differ permanently with respect to their ability to generate income. The welfare criterion we employ is ex-ante (before ability is realized) expected (with respect to uninsurable productivity shocks) utility of a newborn in a stationary equilibrium. Embedded in this welfare criterion is a concern of the policy maker for insurance against idiosyncratic shocks and redistribution among agents of different abilities. Such insurance and redistribution can be achieved by progressive labor income taxes or taxation of capital income, or both. The policy maker has then to trade off these concerns against the standard distortions these taxes generate for the labor supply and capital accumulation decision. We find that in our model the optimal capital income tax rate is significantly positive. The optimal (marginal and average) tax rate on capital is 36%, in conjunction with a progressive labor income tax code that is, to a first approximation, a flat tax of 23% with a deduction that corresponds to about $6,000 (relative to an average income of households in the model of $35,000). We argue that the high optimal capital income tax is mainly driven by the life cycle structure of the model whereas the optimal progressivity of the labor income tax is due to the insurance and redistribution role of the income tax system.
    JEL: E62 H21 H24
    Date: 2007–01
  3. By: Francisco J. Gomes; Laurence J. Kotlikoff; Luis M. Viceira
    Abstract: Governments are known for procrastinating when it comes to resolving painful policy problems. Whatever the political motives for waiting to decide, procrastination distorts economic decisions relative to what would arise with early policy resolution. In so doing, it engenders excess burden. This paper posits, calibrates, and simulates a life cycle model with earnings, lifespan, investment return, and future policy uncertainty. It then measures the excess burden from delayed resolution of policy uncertainty. The first uncertain policy we consider concerns the level of future Social Security benefits. Specifically, we examine how an agent would respond to learning in advance whether she will experience a major Social Security benefit cut starting at age 65. We show that having to wait to learn materially affects consumption, saving, and portfolio decisions. It also reduces welfare. Indeed, we show that the excess burden of government indecision can, in this instance, range as high as 0.6 percent of the agent's economic resources. This is a significant distortion in of itself. It's also significant when compared to other distortions measured in the literature. The second uncertain policy we consider concerns marginal tax rates. We obtain similar results once we adjust for the impact of tax rates on income.
    JEL: H2 H21 H55 H6
    Date: 2007–01
  4. By: Knud Jørgen Munk (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: With reference to the size of the informal sector, Stiglitz (2003) argues that border taxes are superior to VAT in certain developing countries. By way of a quantitative example this paper shows that, while Stiglitz’ claim is probably will turn out to be correct, a large informal sector is not a sufficient condition for border taxes to be preferable to a VAT regime as shown by Keen (2006). Making the case for using border taxes also requires the plausible supplementary assumptions that (i) border taxes are associated with lower administrative costs, and (ii) that this difference is sufficiently large to justify the larger distortionary costs associated with border taxes compared to domestic taxes.
    Keywords: Optimal trade policy, VAT, tax-tariff reform, costs of tax administration, informal sector, developing countries
    JEL: F11 F13 H21
    Date: 2006–12–30
  5. By: Knud Jørgen Munk (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: The adoption of proper rules of normalisation is in general considered a trivial problem which deserves little attention. Possibly for that very reason errors in normalisation have resulted in flawed interpretations of the conditions for optimal commodity taxation. We state based on an explicit representation of the general equilibrium conditions the rules of normalisation in standard optimal tax models. This allows us to provide an intuitive explanation of what determines the optimal tax system. Finally, we review a number of examples where lack of precision with respect to normalisation in otherwise important contributions to the literature on optimal taxation has given rise to misinterpretations of of analytical results.
    Keywords: Public economics, optimal taxation, normalisation rules, p-complements, q-complements, distance function
    JEL: H2
    Date: 2006–12–30
  6. By: Knud Jørgen Munk (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: As is broadly recognized, the straightforward application of the Diamond-Mirrlees (1971) production efficiency theorem implies that when lump-sum taxation is not available, then it is optimal for the government in a small open economy to rely on taxes on the net demand of households rather than on border taxes to finance its resource requirements. However, the theorem does not hold when taxation is associated with administrative costs. The present paper explores the implications of taking into account the costs of tax administration for optimal taxation and for desirable directions of tax-tariff reform in countries at different levels of economic development. The paper clarifies the reasons for, and lends support to, the criticism by Stiglitz (2003) of the IMF and the World Bank's recommendation to developing countries to adopt VAT to replace border taxes.
    Keywords: Optimal taxation, optimal trade policy, VAT, tax-tariff reform, costs of tax administration, informal sector, developing countries
    JEL: F11 F13 H21
    Date: 2006–12–30
  7. By: Manos Matsaganis (Athens University of Economics and Business); Maria Flevotomou (Athens University of Economics and Business)
    Abstract: Fiscal welfare, i.e. the use of the tax system to achieve social policy goals, is assuming ever greater importance throughout Europe and beyond. In housing, the favourable tax treatment of mortgage interest repayments has often coexisted alongside public programmes of housing benefit or social housing. Although the distributional effects of tax expenditure are known to be regressive, the issue has remained relatively under-researched. The paper uses the European tax-benefit model EUROMOD to quantify the distributional impact of mortgage interest tax relief in five European countries: the Netherlands, Sweden, Finland, Italy and Greece. The analysis reveals that higher-income groups capture a disproportionate share of total expenditure on mortgage interest tax relief in all countries, and that this effect is most regressive in the Netherlands and least regressive in Sweden. The paper concludes with a discussion of results and their policy implications.
    Keywords: tax relief, mortgage repayments, inequality, microsimulation
    JEL: H23 I38 R21
    Date: 2007–02
  8. By: Richard Rogerson
    Abstract: This paper argues that it is essential to explicitly consider how the government spends tax revenues when assessing the effects of tax rates on aggregate hours of market work. Different forms of government spending imply different elasticities of hours of work with regard to tax rates. I illustrate the empirical importance of this point by addressing the issue of hours worked and tax rates in three sets of economies: the US, Continental Europe and Scandinavia. While tax rates are highest in Scandinavia, hours worked in Scandinavia are significantly higher than they are in Continental Europe. I argue that differences in the form of government spending can potentially account for this pattern.
    JEL: E2 J2
    Date: 2007–02

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