Optimal Income Taxation with Unemployment and Wage Responses PDF Download

Author: Kory Kroft
Publisher:
ISBN:
Category : Earned income tax credit
Languages : en
Pages : 46

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Book Description
This paper reassesses whether the optimal income tax program features an Earned Income Tax Credit (EITC) or a Negative Income Tax (NIT) at the bottom of the income distribution, in the presence of unemployment and wage responses to taxation. The paper makes two key contributions. First, it derives a sufficient statistics optimal tax formula in a general model that incorporates unemployment and endogenous wages. This formula nests a broad variety of structures of the labor market, such as competitive models with fixed or flexible wages and models with matching frictions. Our results show that the sufficient statistics to be estimated are: the macro employment response with respect to taxation and the micro and macro participation responses with respect to taxation. We show that an EITC-like policy is optimal provided that the welfare weight on the working poor is larger than the ratio of the micro participation elasticity to the macro participation elasticity. The second contribution is to estimate the sufficient statistics that are inputs to the optimal tax formula using a standard quasi-experimental research design. We estimate these reduced-form parameters using policy variation in tax liabilities stemming from the U.S. tax and transfer system for over 20 years. Using our empirical estimates, we implement our sufficient statistics formula and show that the optimal tax at the bottom more closely resembles an NIT relative to the case where unemployment and wage responses are not taken into account.

Author: Kory Kroft
Publisher:
ISBN:
Category : Earned income tax credit
Languages : en
Pages : 59

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Book Description
We derive a sufficient statistics optimal income tax formula in a general model that incorporates unemployment and endogenous wages, to study the shape of the tax and transfer system at the bottom of the income distribution. The sufficient statistics are the macro employment response to taxation and the micro and macro participation responses. We estimate these statistics using policy variation from the U.S. tax and transfer system. Our results suggest that the optimal tax more closely resembles a Negative Income Tax than an Earned Income Tax Credit relative to the case where unemployment and wage responses are not taken into account.

Author: Robin Boadway
Publisher: Cambridge University Press
ISBN: 1108957579
Category : Political Science
Languages : en
Pages : 154

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Book Description
Tax policies are informed by principles developed in the tax theory and policy literature. This Element surveys the policy lessons that emerge from optimal tax analysis since the 1970s. This Element begins with the evolution of tax policy principles from the comprehensive income approach to the expenditure tax approach to normative tax analysis based on social welfare maximization and recounts key results from the optimal income tax analysis inspired by Mirrlees and extended by Diamond to the extensive margin approach. This Element also emphasizes analytical techniques that yield empirically relevant concepts and show the equity-efficiency trade-off at the heart of tax policy. We also extend the analysis to recent literature incorporating involuntary unemployment, and policies like welfare and unemployment insurance.

Author: Emanuel Hansen
Publisher:
ISBN:
Category :
Languages : en
Pages : 82

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Book Description
This paper studies optimal non-linear income taxation in an empirically plausible model with labor supply responses at the intensive (hours, effort) and the extensive (participation) margin. In this model, redistributive taxation gives rise to a previously neglected trade-off between two aspects of efficiency: To reduce the deadweight loss from distortions at the extensive margin, the social planner has to increase distortions at the intensive margin and vice versa. Due to this trade-off, minimizing the overall deadweight loss requires to distort labor supply by low-skill workers upwards at both margins. Building on these insights, the paper is the first to provide conditions under which social welfare is maximized by an Earned Income Tax Credit with negative marginal taxes and negative participation taxes at low income levels.

Author: Stefanie Stantcheva
Publisher:
ISBN:
Category :
Languages : en
Pages : 44

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Book Description
This paper studies optimal linear and nonlinear redistributive income taxation when there is adverse selection in the labor market. Unlike in standard taxation models, firms do not know workers' abilities and competitively screen them through nonlinear compensation contracts. The equilibrium concept used is the Miyazaki-Wilson-Spence (MWS) one, adapted to a labor market with taxes. The government observes neither abilities nor the private market contracts and has to foresee the reaction of firms, in addition to workers. Adverse selection leads to different responses to taxes than in the standard Mirrlees (1971) model, because of the use of work hours as a screening tool by firms, which for higher talent workers results in a rat race. Accordingly, the new optimal income tax formulas include corrective terms for the rat race and redistributive terms take into account the informational rents and cross-subsidies received by lower productivity workers. The most surprising result is that, if the government has sufficiently strong redistributive goals, welfare is higher when there is adverse selection than when there is not. This result is due to the rat race in which high productivity workers are caught, which limits their flexibility to react adversely to distortive taxation. I draw the link to policy praxis by discussing various policies that a government can use to endogenously affect adverse selection. The model also has practical implications for the interpretation, estimation, and use of taxable income elasticities, which are central to optimal tax design.

Author: Jonas Agell
Publisher: MIT Press
ISBN: 0262012294
Category : Business & Economics
Languages : en
Pages : 341

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Book Description
Other chapters examine the effects of tax reforms, including the Earned Income Tax Credit, and the wage-increasing effects of progressive income taxes in a highly unionized labor market. Finally, the contributors analyze the effects of employment protection and tax penalties on the growth of the underground economy. The insights offered in these studies will be valuable to the policy analyst as well as to the academic theorist

Author: Albert Jan Hummel
Publisher:
ISBN:
Category :
Languages : en
Pages : 60

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Book Description
This paper extends the Diamond (1980) model with labor unions to study optimal income taxation and to analyze whether unions can be desirable for income redistribution. Unions bargain with firms over wages in each sector and firms unilaterally determine employment. Unions raise the efficiency costs of income redistribution, because unemployment benefits and income taxes raise wage demands and thereby generate involuntary unemployment. Optimal unemployment benefits and optimal income taxes are lower in unionized labor markets. We show that unions are socially desirable only if they represent (low-income) workers whose participation is subsidized on a net basis. By creating implicit taxes on work, unions alleviate the labor-market distortions caused by income taxation. Numerical simulations demonstrate that optimal taxes and transfers are much less redistributive in unionized labor markets than in competitive labor markets.

Author: Henrik Jacobsen Kleven
Publisher:
ISBN:
Category : Couples
Languages : en
Pages : 76

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Book Description
This paper analyzes the optimal income tax treatment of couples. Each couple is modelled as a single rational economic agent supplying labor along two dimensions: primary and secondary earnings. We consider fully general joint income tax systems. Separate taxation is never optimal if social welfare depends on total couple incomes. In a model where secondary earners make only a binary work decision (work or not work), we demonstrate that the marginal tax rate of the primary earner is lower when the spouse works. As a result, the tax distortion on the secondary earner decreases with the earnings of the primary earner and actually vanishes to zero asymptotically. Such negative jointness is optimal because redistribution from two-earner toward one-earner couples is more valuable when primary earner income is lower. We also consider a model where both spouses display intensive labor supply responses. In that context, we show that, starting from the optimal separable tax schedules, introducing some negative jointness is always desirable. Numerical simulations suggest that, in that model, it is also optimal for the marginal tax rate on one earner to decrease with the earnings of his/her spouse. We argue that many actual redistribution systems, featuring family-based transfers combined with individually-based taxes, generate schedules with negative jointness.

Author: Etienne Lehmann
Publisher:
ISBN:
Category :
Languages : en
Pages : 35

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Book Description
We characterize optimal redistributive taxation when individuals are heterogeneous in their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. Average tax rates are increasing at the optimum. This shifts wages below their laissez faire value and distorts labor demand upwards. The marginal tax rate is positive at the top of the skill distribution even when the latter is bounded. These results are analytically shown under a Maximin objective when the elasticity of participation is decreasing in the skill level and are numerically confirmed under a more general objective.

Author: Stefanie Stantcheva
Publisher:
ISBN:
Category :
Languages : en
Pages : 207

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Book Description
This thesis consists of three chapters on optimal tax theory with endogenous wages. Chapter 1 studies optimal linear and nonlinear income taxation when firms do not know workers' abilities, and competitively screen them through nonlinear compensation contracts, unobservable to the government, in a Miyazaki-Wilson-Spence equilibrium. Adverse selection changes the optimal tax formulas because of the use of work hours as a screening tool, which for higher talent workers results in a "rat race," and for lower talent workers in informational rents and cross-subsidies. If the government has sufficiently strong redistributive goals, welfare is higher when there is adverse selection than when there is not. The model has practical implications for the interpretation, estimation, and use of taxable income elasticities, central to optimal tax design. Chapter 2 derives optimal income tax and human capital policies in a dynamic life cycle model with risky human capital formation through monetary expenses and training time. The government faces asymmetric information regarding the stochastic ability of agents and labor supply. When the wage elasticity with respect to ability is increasing in human capital, the optimal subsidy involves less than full deductibility of human capital expenses on the tax base, and falls with age. The optimal tax treatment of training time also depends on its interactions with contemporaneous and future labor supply. Income contingent loans, and a tax scheme with deferred deductibility of human capital expenses can implement the optimum. Numerical results suggest that full dynamic risk-adjusted deductibility of expenses is close to optimal, and that simple linear age-dependent policies can achieve most of the welfare gain from the second best. Chapter 3 considers dynamic optimal income, education, and bequest taxes in a Barro- Becker dynastic setup. Each generation is subject to idiosyncratic preference and productivity shocks. Parents can transfer resources to their children either through education investments, which improve the child's wage, or through financial bequests. I derive optimal linear tax formulas as functions of estimable sufficient statistics, robust to underlying heterogeneities in preferences. It is in general not optimal to make education expenses fully tax deductible. I also show how to derive equivalent formulas using reform-specific elasticities that can be targeted to already available estimates from existing reforms.