L14: Fundamental Tax Reform and Consumption Taxation Flashcards
why tax capital income at the same rate as labour income?
we shouldn’t
- optimal taxation literature suggests that we shouldn’t tax capital income regardless of SWF
- under certain assumptions, progressive labour income tax cannot be improved upon by adding capital income tax
we want to
- propensity to save and to have capital income may be correlated with unobservable ability
- taxes on capital income provide insurance against risky outcomes
how consumption taxes work
standard in the US - retail sales tax
- taxes consumption directly
standard everywhere else - value added tax
- easier to enforce since it is collected from all businesses, not just retailers
- at each stage of production, business is responsible for all taxes up to that point
progressivity and consumption taxes
VAT Is a proportional tax on all consumption
- exempts certain elements of consumption that are necessities like food
inefficient approach since it distorts choice and subsidy goes mostly to the non-poor
better response to modify the VAT so it can vary by individual according to ability to pay
economic benefits of shifting to progressive consumption taxation
greater economic efficiency
- no tax on saving, so greater capital accumulation
- taxation of consumption from existing wealth
simplification
- measuring capital income is complex, as is resulting tax avoidance
- makes tax system easier to enforce
more traditional tax reform approaches
broadening the income tax base and lowering the income tax rate
when we only tax part of income, it isn’t a constant fraction which distorts decisions
- sensible tax expenditures in terms of design and aim can still increase tax complexity and compliance costs and make enforcement harder
cost of compliance
- taxpayers do not itemise although total deductions exceed standard deduction (itemising is costly and outweights tax benefit)
costs of enforcement
- when there’s a complicated tax system, it is difficult to enforce
- way to make the tax system more enforceable is to have fewer tax deductions for individuals and corporations
politics and economics of tax reform - tax reform act of 1986
broadened the base and reduced rates, representing a victory for tax reform
but soon after, tax rates rose and subsequent reforms complicated the tax code
why the difficulty in maintaining a simple broad-based tax code?
- political pressures are strongest when winners are concentrated and have a lot to gain whereas losers are diffuse and don’t lose as much per person