Lecture 5.4: Labour income taxation

Question 1

Optimal Income taxation

Answer 1

What does a good system of income taxes look like?

Question 2

Equity-effiency tradeoff

Answer 2

Improving equity through tax policy requires more tax progressivity = more redistribution from rich to poor

Question 3

Social welfare function (SWF)

Answer 3

summarizing societal views about how individual welfare is aggregated into societal welfare

what are the weights given to welfare of people at different income levels, when societal decisions are made

Question 4

Laffer Curve

Answer 4

The relation between tax rate and tax revenue; maximum revenue is achieved somewhere in between, at τ*

Question 5

Optimal income taxes determinants

Answer 5

1. total amount of revenue that needs to be collected
2. the elasticity of taxable income (ETI) at income level Z
3. social welfare function: welfare weight given to individuals at income level Z
4. pre-tax income distribution

Question 6

Pre-tax income distribution

Answer 6

i) inequality before taxes (more progressive tax schedule)

ii) number of individuals at income level Z, these are the individuals whose are distorted by marginal taxes at Z

iii) number of individuals above income level Z, marginal taxes below one’s income level contribute to tax collection, but do not affect incentives to work more

Question 7

Elasticity of taxable income (ETI)

Answer 7

ETI captures how income respond to changes in taxation, taking into account broader effects beyond supply only
- other dimensions of work effect that may affect incomes
- other means of reducing income that is subject to taxation (tax avoidance = legal tax planning; or illegal tax evasion)