Income Redistribution Effect of a Shift from Income Deduction to Tax Credit -Discrete Choice Model-Based Simulation Incorporating Labor Supply-

Abstract

As of 2017, debate is ongoing with respect to the revision of the income deduction as part of the income tax reform. One option under consideration is shifting from the income deduction to a tax credit program.The objective of this shift would be enhancing the income redistribution function of the income tax system by strengthening its progressiveness. In relation to the debate on this matter, although some past research papers discussed how the income redistribution function may be affected by a shift from the income deduction to tax credit, no previous analysis has explicitly taken into consideration changes in labor supply that may be caused by the shift. Therefore, in this paper, we conduct simulation concerning the impact of a shift to tax credit on the income redistribution effect in consideration of labor supply and examine how much the shift is expected to contribute to the enhancement of the income redistribution function. The analysis results suggest the possibility that when fixed cost is a determinant factor as to whether or not individual households supply labor, a shift to tax credit may promote labor supply, especially in view of extensive margin, through the income effect although this effect depends on the size of the tax credit amount. However, it should be kept in mind that in this analysis, we were unable to exclude the income effect due to a tax revenue decline. A shift to transferrable basic deduction under debate at the Tax Commission may also be similar in effect to a shift to tax credit. However, when a spouse fs income is close to zero, the deduction is transferred to the other spouse. As a result, the spouse whose income is close to zero receives no income effect, so this measure fs effect of promoting labor market participation is limited. With all those factors considered, a shift to tax credit may be effective in promoting income redistribution not only through a tax system change itself but also through a change in income distribution due to its effect of promoting labor market participation. However, this paper fs analysis is conducted under various preconditions, such as taking dynamic behavior out of consideration for the convenience of simulation conducted within the limitations of data constraints. Therefore, the conclusion arrived at through the analysis should be looked at with some reservations.