Personal income tax and income inequality in Ecuador between 2007 and 2011

Abstract

This paper uses data from individual income tax returns to explore the redistributive effect of personal income tax in Ecuador between 2007 and 2011. Following common practice in tax incidence analysis, we first compute indices of income tax progressivity and redistributive impact. We then mobilize microsimulation techniques to simulate the redistributive effect of personal income tax under different taxable income scenarios. Finally, we calculate the effective tax rates paid by top income groups and derive a range of optimal income taxes for the top 1% income group. We obtain two main empirical results. First, although Ecuador’s personal income tax is highly progressive, its redistributive capacity is low: our findings show that high-income individuals are more likely to reduce their taxable income through legal tax deductions than low-income individuals. Second, while the effective tax rates paid by high-income individuals are relatively low, optimal tax rates could be as high as 63%.