nep-pub New Economics Papers
on Public Finance
Issue of 2008‒02‒09
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Taxing Entrepreneurial Income By Henrekson, Magnus; Sanandaji, Tino
  2. Optimal Ramsey Tax Cycles By Marcus Hagedorn
  3. On the Optimal Timing of Capital Taxes By John Hassler; Per Krusell; Kjetil Storesletten; Fabrizio Zilibotti
  4. Optimal Taxation and Growth with Public Goods and Costly Enforcement By Pierre-Richard Agénor; Kyriakos C. Neanidis
  5. Bigger Countries with Probably Lower Commodity Taxes By Xin Liu; Paul Madden
  6. Corporate tax policy and incorporation in the EU By Ruud A. de Mooij; Gaëtan Nicodème
  7. Tax rates, governance, and the informal economy in high-income countries By Zoe Kuehn
  8. The Effect of Tax Preferences on Health Spending By John F. Cogan; R. Glenn Hubbard; Daniel P. Kessler

  1. By: Henrekson, Magnus (Research Institute of Industrial Economics (IFN)); Sanandaji, Tino (University of Chicago)
    Abstract: Taxation theory rarely takes entrepreneurship into consideration. We discuss how this omission affects conclusions derived from standard models of capital taxation when applied to entrepreneurial income. Some of the defining features of entrepreneurship often omitted by standard capital taxation theory are incorporated into the analysis. This includes the lack of a well-functioning external market for entrepreneurial effort, limited access to external capital and the complementarities between entrepreneurial effort, entrepre-neurial innovation and capital investment. Because of these constraints, the entrepreneurial project is tied to the individual owner-manager. Unlike the typical passive portfolio investor assumed in cost of capital models the entrepreneur is unable to decouple savings decisions from investment decisions, and due to the comple-mentarities in production makes a joint decision on the supply of effort and capital. The returns from success-ful entrepreneurial ventures thus cannot be readily divided into labor and capital income, in stark contrast to what is assumed in standard taxation theory. When unique attributes of entrepreneurship are taken into account, some major conclusions of capital taxation models no longer hold, including the neutrality of capital taxation in owner-managed firms. These results are particularly important for the Nordic system of dual taxation, the theoretical foundation of which relies on the ability to neatly separate capital income from the labor income of the self-employed.
    Keywords: Capital Income Taxation; Dual Income Taxation; Entrepreneurship; Innovation; Institutions; Labor Supply; New Firm Creation; Optimal Factor Taxes; Taxation; Tax Policy
    JEL: E25 G32 H21 H25 L26 L50 M13 O31
    Date: 2008–01–31
  2. By: Marcus Hagedorn
    Abstract: This paper asks whether tax cycles can represent the optimal policy in a model without any extrinsic uncertainty. I show, in an economy without capital and where labor is the only choice variable (a Lucas-Stokey economy), that a large class of preferences exists, where cycles are optimal, as well as a large class where they are not. The larger government expenditures are, the larger the class of preferences for which cycles are optimal becomes. Tax cycles are also more likely to be optimal if frictions (deviations of the model from Walrasian markets) are added. While this cannot be shown in general and will not be true for arbitrary frictions, I demonstrate this in two specific worlds. I consider an economy with search frictions in the labor market, and one with frictions in the goods and credit market. A reasonable parametrization of both economies shows that results change considerably. Even with constant relative risk aversion, cycles can be optimal, whereas this class of preferences rules out cycles in the Lucas-Stokey economy. Finally, I characterize the optimal policy. No more than two tax rates are needed to implement the Ramsey policy both in the Lucas-Stokey economy and in the model with frictions.
    Keywords: Optimal Taxation, Tax Cycles, First-order Approach.
    JEL: H21 E32 E62 E63
    Date: 2007–12
  3. By: John Hassler; Per Krusell; Kjetil Storesletten; Fabrizio Zilibotti
    Abstract: For many kinds of capital, depreciation rates change systematically with the age of the capital. Consider an example that captures essential aspects of human capital, both regarding its accumulation and its depreciation: a worker obtains knowledge in period 0, then uses this knowledge in production in periods 1 and 2, and thereafter retires. Here, depreciation accelerates: it occurs at a 100% rate after period 2, and at a lower (perhaps zero) rate before that. The present paper analyzes the implications of non-constant depreciation rates for the optimal timing of taxes on capital income. The main finding is that under natural assumptions, the path of tax rates over time must be oscillatory. Oscillatory tax rates are optimal when depreciation rates accelerate with the age of the capital (as in the above example), and provided that the government can commit to the path of future tax rates but cannot apply different tax rates in a given year to different vintages of capital.
    Keywords: Asset depreciation, Human capital, Optimal taxation, Oscillations, State-contingent taxes, Tax dynamics.
    JEL: D90 E61 E62 H21 H30
    Date: 2007–12
  4. By: Pierre-Richard Agénor; Kyriakos C. Neanidis
    Abstract: This paper studies optimal direct and indirect taxation rules in an endogenous growth framework where public goods, in the form of infrastructure and health services, affect both production and household utility. Growth- and welfare-maximizing rules are first derived in a setting where collection costs are absent. The analysis is then extended to consider the case where tax collection is costly. Optimal tax rules are derived under alternative assumptions about the nature of these costs. The possibility of multiple equilibria is examined, together with the joint determination of the tax structure and the share of public spending on tax enforcement.
    Date: 2007
  5. By: Xin Liu; Paul Madden
    Date: 2007
  6. By: Ruud A. de Mooij; Gaëtan Nicodème
    Abstract: In Europe, declining corporate tax rates have come along with rising tax-to-GDP ratios. This paper explores to what extent income shifting from the personal to the corporate tax base can explain these diverging developments. We exploit a panel of European data on legal form of business to analyze income shifting via incorporation. The results suggest that the effect is significant and large. It implies that the revenue effects of lower corporate tax rates ¯ possibly induced by tax competition ¯ will partly show up in lower personal tax revenues rather than lower corporate tax revenues. Simulations suggest that between 12% and 21% of corporate tax revenue can be attributed to income shifting. Income shifting is found to have raised the corporate tax-to-GDP ratio by some 0.25%-points since the early 1990s.
    Keywords: Corporate tax; Personal tax; Incorporation; Income shifting
    JEL: H25 L26
    Date: 2008–01
  7. By: Zoe Kuehn
    Abstract: This paper studies the mechanisms behind the informal economy in high-income countries. About 16.3% of output in high-income OECD countries was produced informally in 2001-02. In a recent paper Davis and Henrekson [2004] show that there exists a positive relationship between tax rates and the informal economy for high-income OECD countries. Existing models of the informal economy mostly focus on developing countries. To account for the informal economy in high-income countries, build a model economy, following Lucas [1978], in which agents of different managerial abilities decide to become workers, managers of informal firms, or managers of formal firms. In contrast to formal managers, managers of informal firms do not pay taxes but run the risk of getting caught, taxed, and fined. A calibrated version of the model economy is able to generate the observed differences in informal economy of 21 high-income countries. Although tax rates are crucial for explaining the observed differences in informal economy, the quality of governance, the extent to which these tax rates are enforced, also plays an important role. Policy experiments show that by improving the enforcement of their tax policies countries can reduce informality. A smaller informal economy is accompanied by larger firms and higher productivity.
    Keywords: Informal economies, High-income countries, Tax rates, Governance
    JEL: O17 J22 H2
    Date: 2007–12
  8. By: John F. Cogan; R. Glenn Hubbard; Daniel P. Kessler
    Abstract: In this paper, we estimate the effect of the tax preference for insurance on health spending based on the Medical Expenditure Panel Surveys from 1996-2005. We use the fact that Social Security taxes are only levied on earnings below a statutory threshold to identify the tax preference's impact. Because employer-sponsored health insurance premiums are excluded from Social Security payroll taxes, workers who earn just below the Social Security tax threshold receive a larger tax preference for health insurance than workers who earn just above it. We find a significant effect of the tax preference, consistent with previous research.
    JEL: H2 I1
    Date: 2008–01

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