2. Inequality, Poverty, Taxes, and Transfers Flashcards
What is the equation for national income?
NI=GDP - depreciation of capital + net foreign income
What can be used to measure income inequality?
Lorenz curve and Gini coefficient
Absolute poverty
A fraction of the population with disposable income below poverty threshold a fixed in real terms
Relative poverty
The fraction of the population with disposable income below poverty threshold z relative to median
What is inter generational income mobility?
The idea that children’s success shouldn’t be dependent on parent’s income
When is the tax system neutral?
When there is no transfer of wealth.
Y=z(1-t)
When is the tax system progressive?
When wealth is transferred from rich to poor.
Y=z(1-t) + G where G is universal transfer
When is the tax system regressive?
When the poor pay a greater proportion of their wealth in taxes
Y=z-t where t is a uniform tax
Types of universal transfers
Public education
Public healthcare
Retirement and disability
Unemployment
Types of means tested transfers
Public housing
Free childcare hours
Free school dinners
WTC
UC
What does the tax system reflect?
Social judgments made by people and policy makers as well as lobbying, political economy and interest groups
What are the difference tax brackets?
•PA <£12.5k 0%
•basic £12.5k-£50k 20%
•high £50k-£150k 40%
•higher >£150k 45%
When must you do a self assessment tax return?
When you are self employed, have rental income or earn over £100k
What is the single largest area of gov spending?
The benefits system
What are the two types of tax credits?
Work tax credits WTC and child tax credits CTC
What are the differences in UK and US tax credit systems?
UK provides more generous cash benefits to non working families but there is a much higher phase out rate in the UK
What is the participation tax rate?
The tax rate an individual receives when they move from not earning to earning
Evaluate tax credits
They incentivise working which is good since traditional means tested programs don’t do this. They don’t help those who don’t or can’t work
Assumptions of optimal income tax model with no behavioural response.
•utility is strictly increasing and concave on after tax income
•everybody has the same utility function
•income is fixed for each individual
•N individuals with fixed income
•gov maximises utilitarian objective subject to taxes equalling transfers
What is the optimal tax rate when there are no behavioural responses?
Perfect equalisation if after tax income. 100% MTR and redistribution. Utilitarian with decreasing marginal utility leads to perfect egalitarianism.
Issues with optimal income tax when there are no behavioural responses
People can’t react to tax rates. Many people would reject the view of utilitarianism
Income effect
Causes workers to work less following an increase in income
Substitution effect
Causes workers to work more following an increase in income
How does the marginal tax rate impact the income and substitution effect?
The marginal tax rate discourages work through the substitution effect but encourages work through the income effect.
Which transfer programs always discourage labour supply?
Those which have T(z)<0 and T’(z)>0. This happens when a tax and transfer system is introduced to someone who previously earned z<z*
If the government is Rawlsian how does this effect the optimal tax rate?
It doesn’t, T*= 1/(1+e) is still optimal to make the transfer as large as possible
How is the tax rate affected by elasticity e and equity g?
Tax rate decreases with elasticity and equity
When is tax rate closest to the optimal laffer rate?
When inequality is high and marginal utility decreases fast with income
What does a represent?
The thinness of the top tale?
How is the top rate MTR effected by e and a?
MTR depends negatively on thinness of top tail and elasticity
Tax avoidance
Legal means to reduce tax liability
Tax evasion
Illegal under reporting of income
Why does it matter if the behavioural responses is labour supply falling or tax evasion/ avoidance?
If it is tax evasion/ avoidance then the government can make tax enforcement more stringent
Limitations of model on optimal top tax rate with behavioural response
- Model includes only intensive earnings response
- Model doesn’t include fiscal externalities
- Model doesn’t include classical externalities (charitable donations, spillovers)
Intensive margin
How much an individual works rather than whether they work or not
Why is a high MTR efficient at the bottom?
-they target transfers to the most needy
-earnings are low at the bottom so intensive labour supply response doesn’t generate large output losses
When is the optimal phase out rate negative?
If society sees non- workers as less deserving
What are the effects of a small reform where by the gov increases non working benefits slightly?
- Mechanical fiscal cost
- Welfare effect
- Fiscal cost due to behavioural resoonses
What occurs at the optimum phase out rate?
dM+dB+dW=0
How does the value of go effect the optimum MTR?
If go>1 then MTR>0
If go<1 then MTR<0
Means tested benefits
Eligibility to claim it and how much you receive depends on your income and capital
Conditional cash transfers
Direct payment from government depend on a condition (usually sending children to school or having health check ups)
What is leakage?
It is where people under report their earnings so they can receive transfers despite not actually being eligible
How successful have CCTs been?
•increased consumption for low income families 7-10%
•poverty fell by 2-3%
•enrolment in primary school increased
•impacts on health is hard to find
•no negative outcomes on labour supply
What is an example of an effective in kind transfer?
Transferring rice to people in India where there are price fluctuations in rice
When do households prefer in kind transfers of rice to cash transfers?
Households prefer in kind transfers as long as the marginal utility of income is positively correlated with prices
What are the 3 effects of a reform in the transfer scheme when participation responses are included?
•a mechanical fiscal cost
•a social welfare gain
•a tax revenue gain due to behavioural responses
When is a low lump sum and low MTR at the bottom for phasing out suitable?
When society views non workers as less deserving than workers
When is a high lump sum and high MTR at the bottom suitable?
When society views non workers as more deserving than normal
What is tagging?
A way of increasing the efficiency of means tested benefits by identifying characteristics
When can we use tagging
If we can identify individual characteristics which are
-observable to the gov
-negatively correlated with earnings capacity
-immutable for the individual
How might in kind transfers be better than cash?
-if they are subsidised
-if certain goods which are seen as rights are provided
-if recipients don’t make choices in their own best interest
-if it prevents people that don’t need them from getting them
Intensive labour responses
Refers to hours of work on the job, intensity of work, and occupational choice
Extensive labour responses
Whether an individual chooses to work or not
How can reported earnings for tax purposes vary?
Tax avoidance (legal)
Tax evasion (illegal)
What are the typical labour supply responses of male workers?
Elasticity of labour supply to wages is small =0
Income effect is =-0.1
Compensating elasticity =0.1
What are the typical labour supply responses for women?
Elasticities can vary from 0 to 1
Average is around 0.5 with a significant income effect
What are the issues with OLS in measuring responses of labour supply?
If highly skilled workers have more taste for work then the error term is positively correlated with wage leading to an upward bias.
What is a negative income tax experiment?
Where there is a lump sum transfer combined with a steep phase out rate based on family earnings
What are the findings of NIT experiments?
There is a negative income and substitution effect so people work less when given a transfer and a high phaseout right
What were the findings of natural experiments with lottery winners?
There is a small but significant income effect between -0.05 and -0.1
Results of lotteries in Sweden on labour supply responses
-effects on both extensive and intensive labour supply margin, time persistent
-significant but small income effects =-0.1
-effects on spouse but not as large as winner which rejects the unitary model of household labour supply
Results of tax free jobs in Germany
Fraction of people with second jobs increased from 2.5% to 7% with no offsetting effect on primary work. Look like a big labour supply response but it’s likely that the employers made small jobs to accommodate supply
What happened in the 1996 US welfare reform?
-requiring recipients to go to job training or work
-limiting the duration of benefits
-reducing phase out benefits
What is the Canadian SSP?
Self sufficiency project- randomised experiment that gave welfare recipients an earnings subsidy for 36 months in 1990s. 3 year temporary participation tax rate cut from average of 74.3% to 16.7%
Results of SSP
Strong effect on employment rate
Effect vanished when subsidy stopped
What does the EITC program entail?
-refundable tax credit administered through income tax as annual tax refund
-has phase in (negative MTR), plateau (0 MTR) and phase out (positive MTR)
-theoretically EITC should encourage labour force participation at extensive margin
Outline the theoretical income and sub effect in the phase in, plateau, and phase out of EITC
-phase in: SE: +ve due to increase in net wage. IE: -ve work less. Overall: ambiguous, probably work more
-plateau: SE 0 since net wage is same. IE -ve work less. Overall: work less
Phase out: SE -ve work less. IE: -ve work less. Overall: work less
What is the amount of bunching proportional to?
The compensated elasticity
Why isn’t there more bunching in theory?
- True intensive elasticity of response may be small
- Randomness in income generation process: shows that year to year income variation is too small to erase bunching if elasticity is large
- Frictions: adjustment costs and institutional constraints
- Information and salience
What frictions are associated with changing the number of hours you work?
Search costs
Costs of acquiring info about taxes
Institutional constraints opposed by firms
Results of bunching at kinks
•frictions attenuate observed behavioural responses substantially
•groups with more flexibility respond more
•overall elasticities estimated from bunching are small
•bunching methods are good to detect behavioural responses but not necessarily pin down magnitude of a LR response to a large tax reform
•bunching comes from avoidance/ evasion rather than real behaviour
EITC empirical findings
•some evidence of response along extensive margin but not intensive, possibly due to not understanding the program
•substantial heterogeneity of EITC recipients bunching across states
What are notches
Discontinuations in the budget set
How should notches theoretically effect labour supply?
There should be bunching below the notch and a gap in density just above the notch
Fiscal drag
The rising of wages and inflation will force people into paying more tax
Bunching results at notches
•some bunching below LEL threshold and a dip above it. No bunching at other notches higher up in earrings distribution
•wage earners face substantial frictions to optimise labour choice
•can’t tell whether it’s due to adjustment costs, (fixed pay structures, search/ matching costs), inattention, lack of info, optimisation errors
What is an example of evidence that social norms play a role in labour supply
US female LFP increased by 50% in WW2 and reversed 2/3 afterwards
What is taxable income equal to?
Taxable income = ordinary income + realised capital gains - deductions
What are the channels of taxable income responses?
- Quantitative labour supply responses
- Qualitative labour supply responses
- Changes in savings and portfolio choice
- Legal shifting of income into untaxed or lower taxes form (tax avoidance)
- Illegal under reporting of income (tax evasion)
Intertemporal substitution
Shifting income over time to take advantage of tax changes
Income shifting
Shifting income to another tax base that is taxed less
When do realised capital gains occur?
When an individual sells an asset at a higher price than they bought it for
What is the elasticity of capital gains?
Short term elasticity is very large but long term elasticity is much smaller
When is using a corporate form better for tax advantages?
If (1-corporate tax)(1-distribution tax)> 1-income tax
Summary of behavioural responses to tax
- Evidence of responses to tax changes due to re-timing or income shifting
- Heterogeneity in tax responses due to heterogeneity in shifting opportunities
- Top income shares can change drastically without change in tax rates
- Difficult to know from single country time series the role played by top tax cuts in changes in top incomes
How have top income shares and top tax rates changed over time in OECD countries?
•pre- tax top income shares have increased significantly in most OECD countries
•top tax rates have decreased significantly in most OECD countries since 1960
•correlation between the 2 is strong but not perfect
What are the 3 potential scenarios for why pre tax top incomes and top tax rates are correlated?
- Supply side- top earners work less and earn less when TR is increased
- Tax avoidance/ evasion- top earners avoid more when TR is increased
- Rent seeking- top earners extract more pay (at the expense of the 99%) when top tax rates are low
What did saez 2017 find which suggests that top income share and top tax rates aren’t correlated due to tax avoidance?
Charitable giving and top incomes are strongly positively correlated
What is tax incidence?
The study of the effects of tax policies on prices and the economic welfare of individuals
When would the economic incidence be the same as the legislative incidence?
When prices are constant
Why do liberals favour capital income tax?
Because capital income is concentrated at the high end of the income distribution
Why do conservatives argue that capital income tax shouldn’t be increased?
If people save less because of capital taxes, capital stick may go down also driving down wages and hurting workers
What will the effect a tax has on price depend on?
The elasticity of supply and demand
When do consumers bear the entire burden of the tax?
When there is inelastic demand or perfectly elastic supply
When do producers bear the entire burden of the tax?
When there is inelastic supply or perfectly elastic demand
What is DWL?
The welfare loss created by a tax over and above the tax revenue generated by the tax
When is there no DWL?
With perfectly inelastic demand,
When is there a large DWL?
When demand or supply is elastic
What is the relationship between DWL and the tax rate?
DWL increases with the square of the tax rate
How do pre existing distortions effect the cost of taxation?
They make the cost of taxation higher since we move from a triangle to a trapezoid
Ramsey tax rule
Optimal tax rates for goods are such that the marginal DWL for the last dollar of tax collected is the same across all goods. Goods with inelastic demand should be taxed more
What does the canonical model assume?
Individuals are fully aware of the taxes they pay
Results of salience experiment by cherry et Al 2009
-salience matters
-posting sales taxes reduced demand for those goods
-beer consumption is elastic to excise tax (built in posted price) but not to the sales tax (not built in posted price)
-if tax isn’t salient, demand is inelastic, consumer bears more burden, less DWL
What does the general equilibrium model consider?
The effects of a tax in related markets
Out of labour and capital, which factor faces more if the burden of tax?
Whichever one is less elastic, usually capital in SR
If both capital and labour are highly elastic in LR what must happen for the shop to remain in that location?
Rent must fall since land is now the most inelastic factor
What is the tax incidence on producers of increasing t?
dp/dt= -ø x Ed/(Ed-Ed)
Where ø is the degree to which agents under react to the tax
Why is tax evasion so low in OECD countries given low auditing and low fines?
•unwilling to cheat- social norms and morality
•unable to cheat- probability of being caught may be much higher than observed audit rate because of 3rd party reporting
What are the four ways compliance is achieved by HMRC?
- Direct reporting
- 3rd party reporting
- Behavioural interventions
- Audits
What % of the total missing tax is owed by the 4% of people who owe over £10k?
42%
What are the effects of auditing on LR compliance?
Audits increased reported tax liabilities for 5 years after the audit
What do field experiments find about decreasing tax evasion with normative appeals and threats of audit
Normative appeals don’t work, threats of audit do work
Why don’t employer and employee collude to evade taxes?
In large businesses this is hard to coordinate since the system is automated. In middle income countries some of the wage is often paid in cash as a form of partial tax evasion
Turnover tax
All sales are taxed. Business to consumer and business to business
Retail sales tax
Only business to consumer sales are taxed. There is a strong evasion incentive to list yourself as a business
How did monetary rewards for consumers reporting final sales transactions in São Paulo impact tax evasion?
Reported sales increased by 21% over 4 years. On net, tax revenue net of rewards increased by 9.3%
How do offshore accounts skew stats?
Stats underestimate the net foreign asset positions of countries because they don’t account for this
What % of global financial wealth is held in tax havens?
8%
Ways of stopping off shore evasion
US passed FACTA in 2010 (later extended to OECD +G20) which requires foreign banks to report accounts owned by US persons to IRS air face stiff penalties
Pure public goods
Goods that are perfectly non rival in consumption and are non excludable
Non rival in consumption
One individuals consumption of a good doesn’t affect another’s opportunity to consume the good
Non excludable
Individuals can’t deny each other the opportunity to consume a good
What is the MRS of ice cream for cookies in words
The number of cookies the consumer is willing to give up for 1 ice cream
Samuelson rule
Social efficiency is maximised when the MC is equal to the sum of the MRS’s
Free rider problem
When an investment has a personal cost but a common benefit, selfish individuals will underinvest
Nash equilibrium
Each agent maximises their objective, taking the actions of other agents as given
What things help private provision of a public good be closer to the optimal output?
-some individuals care more than others
-altruism
-warm glow
Warm glow
When individuals care about both the total amount of public good and their particular contribution as well
What are the results of the public good game?
Individuals typically contribute about 50% to public goods. Contributions fall with repetition
When will government forced contributions have an effect?
When initial private contributions are less than the government forced contributions
Why do be give charitably?
-warm glow
-reciprocity
-social pressure
-altruism
What is optimal public good provision a function of?
-the ability of the government to appropriately measure costs and benefits of public projects
-the ability of the government to carry out the socially efficient decision
