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Public Economics > Income tax > Flashcards

Income tax Flashcards

1
Q

Laroque (2005) result

A
  1. Assume preferences are separable between consumption and leisure
  2. Whatever the tax structure, it can be improved by setting commodity taxes to zero and changing income tax to compensate
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2
Q

Atkinson and Stiglitz (1976) result

A
  1. Assume preferences are separable between consumption and leisure
  2. Optimal to have commodity taxes = 0 and redistribute via income tax
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3
Q

What does the assumption that preferences are separable between consumption and leisure mean?

A

All goods equally complementary with leisure

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4
Q

A tax scheme is progressive if…

A

the effective marginal rate increases with income

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5
Q

What does a flatter slope indicate on a graph in net/gross income space?

A

Higher marginal tax rate

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6
Q

Optimal linear marginal tax rate higher if:

A
  1. Avg. elasticity of labour supply (weighted by income) = lower
  2. SWF more concave (inequality aversion higher, so low-income earners more ‘deserving’)
  3. Income distribution more skewed
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7
Q

Diamond (1998) proposition

A
  1. Marginal tax rates increasing above modal skill level if, above this level:
    (i) Elasticity of labour supply constant
    (ii) Distribution of skills = Pareto (or fatter)
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8
Q

Key underlying assumption that Diamond (1998) makes

A

No income effects

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9
Q

Diamond (1998) - A(n) formula interpretation

A
  1. Standard inverse elasticity term (not weighted, just elasticity for that particular person)
  2. Lower marginal tax rate if labour supply more elastic
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10
Q

Diamond (1998) B(n) formula interpretation

A
  1. Average ‘relative deservingness’ for people above skill level n
  2. Higher marginal tax rate if average relative deservingness is lower
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11
Q

Diamond (1998) C(n) formula interpretation

A
  1. How many people tax will affect
  2. Higher marginal tax rate on skill n if:
    (i) There are more people ABOVE skill level n
    (ii) There are fewer AT skill level n
    (iii) Skill level n is lower
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12
Q

What sort of distribution does Saez (2001) show empirically that the income distribution is close to? Implications of this for taxing the rich?

A
  1. Income distribution v. close to Pareto distribution

2. Suggests constant marginal tax rate at top end (see Diamond)

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13
Q

Why do indifference curves slope upwards in gross income/consumption space?

A

Labour is a bad and so, if individual is to work more, must be able to consume more in order to maintain utility

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14
Q

Assumption Mirrlees makes when proving result that optimal marginal rate can never be below zero?

A
  1. Assumes behaviour only focuses on intensive margin of response
  2. i.e. all participate, but if tax rates affect participation decisions (extensive margin), then optimal rates may be negative
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15
Q
  1. General assumption Mirrlees makes in income tax model?

2. Implications?

A
  1. Single-crossing property (agent monotonicity):

2a. Indifference curves only cross once
2b. Agent w/higher skill has lower slope at crossing point

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16
Q
  1. Practical problems with Mirrlees result that the optimal marginal income tax rate on the top earner = 0?
  2. Consequence?
A

1a. Can’t identify who precise top earner is and what their earnings will be
1b. Can’t predict ahead of time (+ cannot design tax schedule after the event)
1c. Likely to change each year

2a. Example - incorrectly identify top earner and set zero marginal rate for all skill levels equal to/above this person person (but there’s actually a higher earner we failed to predict)
2b. Problem - not getting as much tax revenue as we could out of the top earner because we’ve accidentally set a zero marginal rate on some/much of his income

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17
Q
  1. Empirical evidence on the shape of the income distribution
  2. Implication?
A
  1. Saez (2001) - income distribution v. close to Pareto distribution
  2. Diamond (1998) proposition v. relevant
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18
Q
  1. How does a Pareto income distribution link to the Diamond optimal marginal tax rate formula?
  2. Implication?
A
  1. Pareto income distribution means the factor C(n) is constant
  2. Implication - suggests constant marginal tax rate at top end
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19
Q
  1. In terms of the Diamond model, what is the implication of an income distribution that’s even fatter than Pareto?
  2. Policy implication?
A
  1. Factor C(n) is increasing

2. Implication - suggests increasing marginal tax rates at top

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20
Q

What question does Saez (2001) seek to answer?

A

If top marginal tax rate is some constant, what should that rate be?

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21
Q

Gruber and Saez (2002)

A

US LABOUR SUPPLY ELASTICITY EVIDENCE

  1. Estimates for elasticity of labour supply suggest elasticity increases w/income
  2. Taxable income of very high earners may be esp. elastic
  3. Could indicate declining marginal rates at the top
22
Q
  1. Saez (2001) - findings from numerical simulations

2. Reason for findings

A
  1. Numerical simulations indicated that marginal rates should increase between middle/high earners, w/rates for high earners “not lower than 50% and maybe as high as 80%”
  2. Reason – right tail of income distribution better described by Pareto distribution w/thick tails
23
Q

Saez et al (2010) - Mirrlees Review

A

TOP UK TAX RATE

  1. Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%
  2. Similar to current rate of 53% (incl. income tax, NI contributions and indirect taxes)
  3. NO strong case for significantly increasing top marginal rates in the UK

MARGINAL RATES FOR LOW EARNERS

  1. EXTENSIVE MARGIN - v. high marginal rate (close to 100% pre-working tax credit and v. high after it) for those entering work at low earnings due to taxes + withdrawal of benefits, harming incentives to enter labour force
  2. INTENSIVE MARGIN - 73% marginal rate for low/moderate earners as tax credits withdrawn
  3. RECOMMENDATION - increase amount people can earn before benefits withdrawn to improve incentives to enter work

LABOUR SUPPLY ELASTICITY

  1. Responsiveness of hours worked to tax system is v. low for most groups, perhaps zero
  2. Responsiveness of taxable earnings = bigger, which rises for high-earners
24
Q

Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%

A

Saez et al (2010) - Mirrlees Review

25
Q

….. (…..)

Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = …..%

A

Saez et al (2010) - Mirrlees Review

Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%

26
Q

….. (…..)

  1. Numerical simulations indicated that marginal rates should increase between middle/high earners, w/rates for high earners “not lower than …..% and maybe as high as …..%”
  2. Reason – right tail of income distribution better described by …..
A

Saez (2001)

  1. Numerical simulations indicated that marginal rates should increase between middle/high earners, w/rates for high earners “not lower than 50% and maybe as high as 80%”
  2. Reason – right tail of income distribution better described by Pareto distribution w/thick tails
27
Q
  1. What does Saez (2001) mean by an unbounded distribution?

2. What implication does this have for the top marginal tax rate?

A
  1. Top earnings not known in advance, but can instead think that potential earnings drawn randomly from Pareto distribution
  2. Mirrlees’ zero top rate result has no policy relevance
28
Q

If participation effects are important, what is the implication for optimal income transfers to the poor?

A
  1. Optimal to give higher transfers to low-income than non-workers
  2. Reason - encourages people to work, given evidence of importance of extensive margin for low-earners
29
Q

3 key recommendations of Diamond and Saez (2011)

A
  1. Very high earnings should be subject to rising and high marginal rates
  2. Policy toward low earners should include subsidy to earnings and phase out subsidisation at relatively high rate
  3. Capital income should be taxed
30
Q

Evidence that labour supply responses along extensive (participation) margin are important

A

Diamond and Saez (2011)

  1. Compelling evidence of substantial labour supply responses to transfers along extensive margin (participation, whether/not to work)
  2. Extensive elasticity of choosing whether to participate large for those w/low incomes, relative to intensive elasticity of choosing no. hours to work
31
Q

Compelling evidence of substantial labour supply responses to transfers along extensive margin (participation, whether/not to work)

A

Diamond and Saez (2011)

32
Q

Extensive elasticity of choosing whether to participate large for those w/low incomes, relative to intensive elasticity of choosing no. hours to work

A

Diamond and Saez (2011)

33
Q

Diamond and Saez (2011)

A

EXTENSIVE LABOUR SUPPLY ELASTICITY

  1. Compelling evidence of substantial labour supply responses to transfers along extensive margin (participation, whether/not to work)
  2. Extensive elasticity of choosing whether to participate large for those w/low incomes, relative to intensive elasticity of choosing no. hours to work

TOP-END ELASTICITY ESTIMATES

  1. Considerable uncertainty about long-run behavioural responses to top tax rates
  2. Estimates of high labour supply elasticities for top earners (e.g. Gruber and Saez 2002) may be over-estimates due to importance of tax avoidance responses, which often involves shifting timing of taxes paid
  3. Tax avoidance component of elasticity response can be reduced by broadening base/reducing deductions

POLICY RECOMMENDATIONS

  1. Very high earnings should be subject to rising and high marginal rates
  2. Policy toward low earners should include subsidy to earnings and phase out subsidisation at relatively high rate
  3. Capital income should be taxed
34
Q
  1. State the Chamley-Judd result of zero capital taxation
  2. Explain
  3. Key assumption?
A
  1. In model w/infinitely-lived agents, optimal tax on capital income = 0

2a. Constant capital income tax creates growing wedge between current and future consumption as time horizon grows
2b. To avoid tax compounding that grows w/o limit as time horizon extends, optimal average rate must be zero

  1. Key assumption – individuals make rational decision about savings across v. long horizons
35
Q
  1. Key assumptions of Chamley-Judd result of zero capital taxation
  2. Evaluate these
A

1a. Infinitely-lived agents
1b. Individuals make rational decision about savings across v. long horizons

2a. Savings decisions not 100% rational, but influenced by psychology (e.g. self-control) or small transaction costs (e.g. default options)
2b. Empirical evidence shows concern for heirs, but not sufficient to support rigorous dynasty model required by Chamley and Judd

36
Q

Reasons to tax capital income

A
  1. DIFFICULT TO DISTINGUISH CAPITAL AND LABOUR INCOME
    (i) After 1993 Finnish tax reform to lower rate on capital income, significant shifts of labour to capital income among self-employed
  2. EASE TAX BURDEN ON BORROWING CONSTRAINED
    (i) Capital income taxes fall on those not borrowing constrained (they have capital)
    (ii) raising revenue from capital income tax allows for lower earned income tax (incl. on poorer, borrowing constrained)
  3. POSITIVE CORRELATION BETWEEN EARNINGS OPPORTUNITIES AND SAVING PROPENSITIES
    (i) Taxing savings might contribute to efficient redistributive taxation by indirectly identifying those w/higher earnings abilities
37
Q

Intuition for why it is not optimal to have a marginal tax rate below zero

A
  1. Negative marginal tax rate = subsidy to work

2. If subsidise work, then high-skilled (who gain more from working) gain relative to low-skilled

38
Q
  1. Marginal tax rates increasing above modal skill level if, above this level:
    (i) Elasticity of labour supply constant
    (ii) Distribution of skills = Pareto (or fatter)
A

Diamond (1998)

39
Q

Under what conditions is the marginal tax rate increasing above the modal skill level, according to Diamond (1998)?

A

(i) Elasticity of labour supply constant

ii) Distribution of skills = Pareto (or fatter

40
Q

Saez (2001)

A

1a. Income distribution v. close to Pareto distribution
1b. Suggests constant marginal tax rate at top end (see Diamond)

2a. Numerical simulations indicated that marginal rates should increase between middle/high earners, w/rates for high earners “not lower than 50% and maybe as high as 80%”
2b. Reason – right tail of income distribution better described by Pareto distribution w/thick tails

41
Q

US LABOUR SUPPLY ELASTICITY EVIDENCE

  1. Estimates for elasticity of labour supply suggest elasticity increases w/income
  2. Taxable income of very high earners may be esp. elastic
  3. Could indicate declining marginal rates at the top
A

Gruber and Saez (2002)

42
Q

TOP-END ELASTICITY ESTIMATES

  1. Considerable uncertainty about long-run behavioural responses to top tax rates
  2. Estimates of high labour supply elasticities for top earners (e.g. Gruber and Saez 2002) may be over-estimates due to importance of tax avoidance responses, which often involves shifting timing of taxes paid
  3. Tax avoidance component of elasticity response can be reduced by broadening base/reducing deductions
A

Saez and Diamond (2011)

43
Q

Possible reasons that very long-run elasticity of labour supply responses might be higher, esp. for top-earners?

A

In long-run, high marginal rates may impact:

  1. Decisions about education and career choice (e.g. very high marginal rate might raise lots of money today, but discourage future earnings)
  2. Decisions about location (e.g. banker might move to New York from London)
44
Q

If participation effects are important, what is the implication for optimal income transfers to the poor?

A
  1. Optimal to give higher transfers to low-income than non-workers
  2. Reason - encourages people to work, given evidence of importance of extensive margin for low-earners
45
Q
  1. Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%
  2. Similar to current rate of 53% (incl. income tax, NI contributions and indirect taxes)
  3. NO strong case for significantly increasing top marginal rates in the UK
A

Saez et al (2010) - Mirrlees Review

46
Q

MARGINAL RATES FOR LOW EARNERS

  1. EXTENSIVE MARGIN - v. high marginal rate (close to 100% pre-working tax credit and v. high after it) for those entering work at low earnings due to taxes + withdrawal of benefits, harming incentives to enter labour force
  2. INTENSIVE MARGIN - 73% marginal rate for low/moderate earners as tax credits withdrawn
  3. RECOMMENDATION - increase amount people can earn before benefits withdrawn to improve incentives to enter work
A

Saez et al (2010) - Mirrlees Review

47
Q

2 main dimensions of labour supply response to tax change?

A
  1. ‘Real’ behavioural effect (on hours worked)

2. Effect on taxable earnings (e.g. through tax avoidance, changing labour to capital income)

48
Q

….. (…..) - Mirrlees Review

TOP UK TAX RATE

  1. Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = …..%
  2. Similar to current rate of …..% (incl. income tax, NI contributions and indirect taxes)
  3. Conclusion - …..
A

Saez et al (2010) - Mirrlees Review

TOP UK TAX RATE

  1. Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%
  2. Similar to current rate of 53% (incl. income tax, NI contributions and indirect taxes)
  3. Conclusion - NO strong case for significantly increasing top marginal rates in the UK
49
Q

….. (…..) - Mirrlees Review

MARGINAL RATES FOR LOW EARNERS

  1. EXTENSIVE MARGIN - v. high marginal rate (close to …..% pre-working tax credit and v. high after it) for those entering work at low earnings due to taxes + withdrawal of benefits, harming incentives to enter labour force
  2. INTENSIVE MARGIN - …..% marginal rate for low/moderate earners as tax credits withdrawn
  3. RECOMMENDATION - …..
A

Saez et al (2010) - Mirrlees Review

MARGINAL RATES FOR LOW EARNERS

  1. EXTENSIVE MARGIN - v. high marginal rate (close to 100% pre-working tax credit and v. high after it) for those entering work at low earnings due to taxes + withdrawal of benefits, harming incentives to enter labour force
  2. INTENSIVE MARGIN - 73% marginal rate for low/moderate earners as tax credits withdrawn
  3. RECOMMENDATION - increase amount people can earn before benefits withdrawn to improve incentives to enter work
50
Q

TOP UK TAX RATE

  1. Based on estimates of labour supply elasticity of rich, UK government would maximise revenue w/overall marginal rate on highest earners = 57%
  2. Similar to current rate of 53% (incl. income tax, NI contributions and indirect taxes)
  3. Conclusion - NO strong case for significantly increasing top marginal rates in the UK
A

Saez et al (2010) - Mirrlees Review

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