nep-pub New Economics Papers
on Public Finance
Issue of 2010‒11‒06
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Optimal Taxation of Education with an Initial Endowment of Human Capital By Christoph Braun
  2. Using a Microeconometric Model of Household Labour Supply to Design Optimal Income Taxes By Rolf Aaberge; Ugo Colombino
  3. "Optimal taxes and penalties when the government cannot commit to its audit policy" By Leandro Arozamena; Martin Besfamille; Pablo Sanguinetti
  4. Why Lower Tax Rates May be Ineffective to Encourage Investment: The Role of The Investment Climate By S. VAN PARYS; S. JAMES
  6. The Effectiveness of Tax Incentives in Attracting FDI: Evidence from the Tourism Sector in the Caribbean By S. VAN PARYS; S. JAMES
  7. Mergers in Fiscal Federalism By Marie-Laure Breuillé; Skerdilajda Zanaj
  8. Time-varying fiscal policy in the U.S. By Manuel Coutinho Pereira; Artur Silva Lopes
  9. The Impact of Income Distribution on the Length of Retirement By Dean Baker; David Rosnick
  10. Demographic Changes and Pension Reform in the Republic of Korea By Hyungpyo Moon

  1. By: Christoph Braun
    Abstract: Bovenberg and Jacobs (2005) and Richter (2009) derive the education efficiency theorem: In a second-best optimum, the education decision is undistorted if the function expressing the stock of human capital features a constant elasticity with respect to education. I drop this assumption. The household inherits an initial stock of human capital, implying that the aforementioned elasticity is increasing. In a two-period Ramsey model of optimal taxation, I show that the education efficiency theorem does not hold. In a second-best optimum, the discounted marginal social return to education is smaller than the marginal social cost. The household overinvests in human capital relative to the first best. The government effectively subsidizes the return to education.
    Keywords: Optimal taxation, human capital
    JEL: H21 I28 J24
    Date: 2010–10
  2. By: Rolf Aaberge; Ugo Colombino
    Abstract: The purpose of this paper is to present an exercise where we identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue. Empirical applications of optimal taxation theory have typically adopted analytical expressions for the optimal taxes and then imputed numerical values to their parameters by using "calibration" procedures or previous econometric estimates. Besides the restrictiveness of the assumptions needed to obtain analytical solutions to the optimal taxation problem, a shortcoming of that procedure is the possible inconsistency between the theoretical assumptions and the assumptions implicit in the empirical evidence. In this paper we follow a different procedure, based on a computational approach to the optimal taxation problem. To this end, we estimate a microeconomic model with 78 parameters that capture heterogeneity in consumption-leisure preferences for singles and couples as well as in job opportunities across individuals based on detailed Norwegian household data for 1994. For any given tax rule, the estimated model can be used to simulate the labour supply choices made by single individuals and couples. Those choices are therefore generated by preferences and opportunities that vary across the decision units. We then identify optimal tax rules – within a class of 9-parameter piece-wise linear rules - by iteratively running the model until a given social welfare function attains its maximum under the constraint of keeping constant the total net tax revenue. The parameters to be determined are an exemption level, four marginal tax rates, three "kink points" and a lump sum transfer that can be positive (benefit) or negative (tax). We explore a variety of social welfare functions with differing degree of inequality aversion. All the social welfare functions imply monotonically increasing marginal tax rates. When compared with the current (1994) tax systems, the optimal rules imply a lower average tax rate. Moreover, all the optimal rules imply – with respect to the current rule – lower marginal rates on low and/or average income levels and higher marginal rates on relatively high income levels. These results are partially at odds with the tax reforms that took place in many countries during the last decades. While those reforms embodied the idea of lowering average tax rates, the way to implement it has typically consisted in reducing the top marginal rates. Our results instead suggest to lower average tax rates by reducing marginal rates on low and average income levels and increasing marginal rates on very high income levels.
    Keywords: Labour supply; optimal taxation; random utility model; microsimulation
    JEL: H21 H31 J22
    Date: 2010
  3. By: Leandro Arozamena; Martin Besfamille; Pablo Sanguinetti
    Abstract: We examine the problem of a utilitarian government that sets taxes and fines for evaders but cannot commit to any enforcement policy. Given the tax law, the government and taxpayers —some of whom are honest— play a report-audit game that, depending on taxes, fines and audit costs, generates either full evasion and no audits, or partial evasion and random auditing. Anticipating both possibilities, we characterize the optimal tax law. We show that it may be optimal for the government not to fine evaders as a way to commit not to audit. Moreover, social welfare is nonmonotonic in the audit cost.
    Keywords: Tax rates, Tax evasion, Enforcement, Audit costs, No commitment, Mixed-strategy equilibrium.
    JEL: D82 H26
    Date: 2010–10
    Abstract: In this paper we first analyze theoretically how the investment climate can affect the impact of corporate taxation on investment in a simple tax competition model where the corporate tax revenues are used to improve the investment climate. We find that an improvement of the investment climate increases the sensitivity of capital to the tax rate if the investment climate is very effective at enhancing the productivity of capital or if the investment climate enhances the productivity of capital much more when the initial investment climate is unattractive than when the initial investment climate is already attractive. As a result, the model calls for the estimation of an investment equation where the tax variable is moderated by an investment climate variable.<br> We estimate such an investment equation using a unique panel dataset of effective corporate tax rates of 80 countries, including countries with an unattractive and countries with an attractive investment climate, for the period 2005-2008. We find two important results. First, a better investment climate increases the sensitivity of FDI to the tax rate. Second, in the worst investment climate countries, FDI reacts not negatively to a rise in the tax rate. These results have important policy implications. For bad investment climate countries it is ineffective to lower the tax rate to compensate for the bad investment climate. Instead, these countries should focus on improving the basic investment climate.
    Keywords: tax competition, investment climate, developing countries, Foreign Direct Investment, corporate tax
    Date: 2010–09
  5. By: Niek Schoeman (Department of Economics, University of Pretoria); Yolande van Heerden (Department of Economics, University of Pretoria)
    Abstract: The use of micro-simulation tax modelling techniques is reasonably well-documented in a broad spectrum of literature in the field of public economics. This article is primarily concerned with assessing the revenue base for individuals by means of such a micro-simulation tax model, using the 2005/2006 Income and Expenditure survey. The challenge was to structure the model in such a way that differences in individual behaviour, the economic environment and the income levels of individuals be captured to reflect the true national economy. The model developed is an extension of the MS model framework as structured by Thompson and Schoeman (2006) as well as Wilkinson (2009). It is different though in the sense that StatsSa data is aligned with published data from the South African Revenue Services (SARS). Given the scarcity of data (limited surveys) this model is a static model assuming that the population characteristics do not change significantly over the period of the analysis and that it remains useful in the short term. The structured model applies a tax calculator to compute the tax liability for each individual under the 2005/2006 tax regulations and rules. The results based on IES data is then benchmarked against the latest available published SARS data in the bulletin Tax Statistics (2009) and the relevant data in the latest (2010) publication Budget Review from the National Treasury. An analysis based on unadjusted data from the IES shows a substantial difference in tax liability compared to official tax figures published by SARS (R65 billion compared to the SARS figure of R101 billion for the 2005/06 IES survey3 year). After benchmarking critical values and the imputation of missing data the numbers are now much closer (R105 billion compared to the SARS R101 billion). The analysis is concluded with some policy scenarios showing the impact of a change in marginal tax rates and the tax threshold. The results highlight the sensitivity of high income earners to changes in tax policy.
    Keywords: Micro-simulation, Tax revenue base, Personal income tax
    JEL: D31 H24
    Date: 2010–10
    Abstract: We investigate to what extend tax incentives have been effective in attracting Foreign Direct Investment in the tourism sector in the Caribbean in the period 1997-2007. More precisely, we test whether the neoclassical investment theory prediction that tax incentives, by lowering the user cost of capital, raise investment, holds in the Eastern Caribbean Currency Union (ECCU). We use differences in difference to assess the impact of an important change in tax incentives for tourism investment in Antigua and Barbuda in 2003. The other ECCU countries serve as excellent control group countries since the small islands share the same currency, coordinate macroeconomic policies to some extent, have similar geographical characteristics, and compete for the same big international tourism corporations. Accounting for other factors driving tourism FDI in this region, we find that tourism investment in Antigua and Barbuda after 2003 increased significantly more than investment in the other six ECCU countries due to the tourism tax incentives reform. This study is one of the first to assess the impact of sector specific tax incentives on investment in developing countries. Moreover, while previous studies relied on cross sectional differences, our differences in difference approach offers a cleaner way to identify the effect of the tax incentives policy.
    JEL: H21 H25 H32 F21
    Date: 2010–09
  7. By: Marie-Laure Breuillé (Université Catholique de Louvain); Skerdilajda Zanaj (CREA, University of Luxembourg)
    Abstract: This paper analyzes mergers of regions in a two-tier setting with both horizontal and vertical tax competition. The merger of regions induces three effects on regional and local tax policies, which are transmitted both horizontally and vertically: i) an alleviation of tax competition at the regional level, ii) a rise in the regional tax base, and iii) a larger internalization of tax externalities generated by cities. It is shown that the merger of regions increases regional tax rates while decreasing local tax rates. This Nash equilibrium with mergers is then compared with the Nash equilibrium with coalitions of regions.
    Keywords: Mergers, Tax Competition, Fiscal Federalism
    JEL: H73 H25
    Date: 2010
  8. By: Manuel Coutinho Pereira; Artur Silva Lopes
    Abstract: To investigate time heterogeneity in the e¤ects of fiscal policy in the U.S., we use a non-recursive, Blanchard and Perotti-like structural VAR with time-varying parameters, estimated through Bayesian simulation over the 1965:2-2009:2 period. Our evidence suggests that fiscal policy has lost some capacity to stimulate output but that this trend is more pronounced for taxes net of transfers than for government expenditure, whose e¤ectiveness<br>declines only slightly. Fiscal multipliers keep conventional signs throughout. An investigation of changes in ?scal policy conduct indicates an increase in the countercyclical activism of net taxes over time, which appears to have reached a maximum during the 2008-09 recession.
    JEL: C11 E32 E62
    Date: 2010
  9. By: Dean Baker; David Rosnick
    Abstract: Social Security has made it possible for the vast majority of workers to enjoy a period of retirement in at least modest comfort without relying on their children for support. The average length of retirement has increased consistently since the program was started in 1937. However, the increase in the normal retirement age from 65 to 67 that is being phased in over the years 2003 to 2022 largely offsets the increase in life expectancy. As a result, workers who work long enough to collect their full benefits will see little gain in the expected length of their retirement over this period. These gains have gone overwhelmingly to workers in the top half of the income distribution. Consequently, the increase in retirement age will offset the gains in retirement lengths for the bottom half — even if there is no further inequality in improvements in life expectancy. If such inequality in improvements persist, then the bottom half of workers born in 1973 will have retirements no longer than those born in 1937.
    Keywords: social security, retirement, retirement age, life expectancy
    JEL: H H6 H62 H63 H68 J J1 J14 J18 J3 J32 J38
    Date: 2010–10
  10. By: Hyungpyo Moon
    Abstract: This paper conducted a quantitative assessment based on a simulation analysis of what impact the reformed Korean National Pension Act on July 2007 could bring on its sustainability, equity, and adequacy, and then it inquires into policy implications for further development of the system. [ADBI Working Paper 135]
    Keywords: quantitative, Korean National Pension Act, sustainability, equity, adequacy, development
    Date: 2010

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