Corrective Taxes Research Articles

Optimal tax rules and addictive consumption

This paper studies implementation of the social optimum in a model of addictive consumption. We consider corrective taxes that address inefficiencies due to negative externalities, imperfect competition, and self-control problems. Our setup allows us to evaluate how such taxes are affected by (i) market power and (ii) a requirement for implementation to be time consistent. Together, these features can imply significantly lower taxes. We provide a general characterization of the optimal tax rule and illustrate it with two examples.

From Optimal Tax Theory to Applied Tax Policy

This paper aims to provide a perspective on the ideal tax system using insights from optimal-tax theory supplemented with empirical evidence. These insights are applied to actual policy questions regarding the progressiveness of the labor income tax, in-work tax credits, the design of the capital income tax, the taxation of housing and pensions, the role of indirect taxes, optimal environmental taxes, and corrective taxes on alcohol and tobacco.

From Optimal Tax Theory to Applied Tax Policy

This aims to provide a perspective on the ideal tax system, using insights from optimal-tax theory supplemented with empirical evidence. These insights are applied to actual policy questions regarding the progressiveness of the labor-income tax, in-work tax credits, the design of the capital-income tax, the taxation of housing and pensions, the role of indirect taxes, optimal environmental taxes, and corrective taxes on alcohol and tobacco.

Sovereign wealth funds, portfolio choice and corrective taxes

In a setting where investors have preferences for future wealth, sovereign wealth funds should invest relatively less in equities than the representative private investor. Tax asymmetries make it relatively more attractive for sovereign wealth funds to invest in fixed income than in stock markets. A high fraction invested in equities may be an indication that the sovereign wealth fund's principal has other preferences than the representative private investor. Host countries may levy corrective taxes on foreign sovereign wealth funds based on the ‘private behaviour equivalent’ principle, in order to reduce potential social costs related to the sovereign wealth funds' investment activities.

Comparing Apples and Oranges? Public, Private, Tax, and Criminal Law in Financial Markets Regulation

This paper discusses different means of regulation, taking the example of post-crisis financial markets regulation. It is remarkable that the general discussion about reforming financial regulation centres on the substantive standards of the new rules and neglects the problem of choosing the right regulatory instruments. The paper focuses on four basic instruments of law enforcement (administrative sanctions; civil liability; corrective taxation; criminal sanctions) and takes three examples of regulatory choice in financial markets regulation. Using a number of different yardsticks for comparison, it analyses the relative strengths and weaknesses of the four instruments and employs a cost-benefit analysis.It turns out that civil liability – while limited in its scope – exhibits the best cost-benefit ratio. Criminal law, by contrast, seems very inefficient. Administrative law and corrective taxation come in second best. The return from using these instruments has to be assessed on a case-by-case basis.

Should the Good and the Selfish be Taxed Differently?*

AbstractIn this paper, we consider an environment where individual actions have externalities and two types of agents exist: agents with social preferences (the good) and selfish agents. Selfish agents have pay‐off functions that do not take into account social welfare. The pay‐off of an agent is a linear combination of social welfare and the pay‐off of a selfish agent. We demonstrate that the corrective tax rates that maximize social welfare do not depend on the degree of social preferences. Hence, the good and the selfish should not be taxed differently.

International fuel tax assessment: an application to Chile

AbstractGasoline and diesel fuel are heavily taxed in many developed and some emerging and developing countries. Outside the United States and Europe, however, there has been little attempt to quantify the external costs of vehicle use, so policy makers lack guidance on whether prevailing tax rates are economically efficient. This paper develops a general approach for estimating motor vehicle externalities, and hence corrective taxes on gasoline and diesel, based on pooling local data with extrapolations from US evidence. The analysis is illustrated for the case of Chile, although it could be applied to other countries.

Taxes, Status Goods, and Piracy

This paper studies the design of indirect redistributive taxation and of corrective taxation, as well as the formation of equilibrium indirect tax policies via a political process, in the presence of status goods, allowing for the possibility that illegal copies of those goods may be purchased on black markets (the phenomenon of piracy). Heavy taxation of status goods, despite the fact these are typically overconsumed, is not particularly favoured in a social welfare maximisation context, because the tax rate is highly distortionary, due to the presence of piracy. Corrective taxation, aimed at remedying the inefficiencies associated with the consumption externalities generated by the status goods, is made ineffective by piracy. In contrast with the normative results, the median voter model predicts an inefficiently large tax rate on status goods when piracy is widespread.

Free Entry, Regulatory Competition, and Globalization

This paper examines the optimal entry policy towards oligopoly in a globalized world. In an open economy free entry is socially suboptimal, but corrective tax policy to curb entry proves insucient unless internationally harmonized. Thus, while conferring the gains from trade, globalization prevents countries from pursuing the optimal entry policy. When countries are small, the gains from trade dominate the losses from a suboptimal entry policy, but as markets grow the result is reversed, making trade inferior to autarky. Therefore, the need for tax harmonization grows as the world economy grows. This paper also contributes to the international tax competition literature through the discovery of the reverse home market eect.

The End of Market Discipline? Investor Expectations of Implicit State Guarantees

We find that bondholders of major financial institutions have an expectation that the government will shield them from losses and, as a result, they do not accurately price risk. While bond credit spreads are sensitive to risk for most financial institutions, credit spreads lack risk sensitivity for the largest institutions. This expectation of public support constitutes a subsidy to large financial institutions, allowing them to borrow at government-subsidized rates. The implicit subsidy provided large institutions an annual funding cost advantage of approximately 28 basis points on average over the 1990-2010 period, peaking at more than 120 basis points in 2009. The total value of the subsidy amounted to about $20 billion per year, topping $100 billion in 2009. Passage of Dodd-Frank did not eliminate expectations of government support. The cost of this implicit insurance could be internalized by imposing a corrective tax. Requiring financial institutions to shoulder the full cost of their debt would help create a more stable and efficient financial system.

Corrective Taxation versus Liability as a Solution to the Problem of Harmful Externalities

AbstractAlthough the corrective tax has long been viewed by economists as a desirable remedy for the problem of harmful externalities, its actual use has been limited, mainly to the domain of pollution. Liability, in contrast, has great importance in controlling harmful externalities. I compare the tax and liability in theory and suggest that the conclusions help explain the observed predominance of liability over taxation, except in the area of pollution. The following factors are emphasized: inefficiency of incentives under taxes when the state cannot practically take into account all variables that significantly affect expected harm; efficiency of incentives under strict liability, which requires only that actual harms be measured; efficiency of incentives under the negligence rule; administrative cost advantages of liability deriving from its being applied only when harm occurs; and dilution of incentives under liability when suit is unlikely or injurers cannot pay fully for harm.

Smoking bans and the secondhand smoking problem: an economic analysis

Smoking bans are gaining widespread support in the European Union and other countries. The vast majority of these bans are partial bans given that smoking is still permitted in certain places. This article investigates the role of partial smoking bans in coping with externalities caused by the secondhand smoking problem. Although it is widely known that Pigouvian taxation is superior to a perfect ban, this result does not necessarily carry over to a partial ban because taxes cannot (easily) be differentiated according to location. We show that under an easy and intuitive condition, (1) enacting a partial smoking ban alone always improves social welfare (a) in an unregulated society and (b) even in a regulated society if externalities can be eliminated, and (2) it is ensured that a combination of Pigouvian tax and a partial smoking ban leads to a higher social optimum than implementing corrective Pigouvian taxation alone.

Efficiency properties of binary ecolabeling

Abstract We investigate efficiency properties of binary ecolabels in a homogeneous good market with heterogeneous consumers. Faced with the minimum technology standard, firms make endogenous entry, certification, and price/quantity decisions. We consider both perfect and imperfect competition with or without sunk fixed costs. Our findings are as follows. Ecolabeling alone does not achieve the first-best outcome and, to achieve the second best, may need to set the standard less strict than the efficient level. Without sunk fixed costs, ecolabeling can achieve the first-best outcome provided that both the technology standard and the complementary pollution tax are set at efficient levels. With sunk fixed costs, however, differential excise taxes that would restore allocative efficiency induce more entry than optimal, and thus, can be even welfare decreasing relative to no tax outcome. Tightening the technology standard may ameliorate such an adverse effect of the corrective tax system by reducing excessive entry and pollution per output by the certified firms.

The influence of positionality in car-purchasing behaviour on the downsizing of new cars

This paper presents results from stated choice experiments looking at the influence of positionality in peoples’ choices of passenger cars in the Netherlands. It provides evidence that cars are positional goods and that selected car attributes such as size, engine capacity and interior add to their positionality. This suggests downsizing of cars through corrective taxation aimed at CO 2 benefits would lead to lower welfare costs than micro-economic welfare theory suggests. The experiments also show that car buyers are very heterogeneous and have a strong predisposition to choose a type of car and its attributes similar to their current car.

Public Spending and Taxation with Non-cooperative Families

We develop a political economy model of income taxation and public spending, in which we pay special attention to the composition of the latter. The significant economic unit is taken to be the household. Each household is made of two agents, positively sorted by wage, who engage in the non-cooperative home production of a household public good. This leads to an inefficient laissez-faire equilibrium. We consider three policy instruments, a tax rate on labour income, and two types of transfer to the household (cash versus in-kind). The in-kind transfer is one of the inputs in the home production process. Since the pre-intervention equilibrium is inefficient, there is a general consensus among the agents that some corrective taxation is needed; however, those at bottom of the income distribution, who prefer a redistributive (as opposed to corrective) policy, favour a combination of high taxes and cash transfers, while those at the top would rather have low taxes and in-kind provision. Assuming, as seems plausible according to the empirical evidence, that political participation and income are positively correlated, we find that the decisive agent, i.e. the one whose preferred policy wins at the political equilibrium, has income above the mean. (JEL codes: D13, D72, H31)

The happiness puzzle: analytical aspects of the Easterlin paradox

We apply an optimizing model with relative comparisons (habit formation) in consumption and labour supply to the economics of happiness, specifically the 'Easterlin paradox'. Studying a generalization of the paradox, which we label the 'happiness puzzle', we analyse ways in which income growth affects happiness. In our model, those factors include agents' risk aversion; whether the economy experiences balanced or unbalanced growth; how non-pecuniary factors affect well-being; and the degree of market imperfections. We also demonstrate that the dynamic specification of habit formation rather than its mere existence matters for whether the happiness puzzle arises on a balanced growth path. Only when habit is modelled in ratio form, does this possibility open up. Our model thus bridges the gap between theory, empirics and social policy. It provides a basis for studying a number of specific policy issues, such as corrective taxes. Copyright 2012 Oxford University Press 2011 All rights reserved, Oxford University Press.

Media Firm Strategy and Advertising Taxes

Empirical evidence suggests that people dislike ads in TV programs and other media products. In such situations standard economic theory prescribes that the advertising volume can be optimally reduced by levying a tax on ads. However, making use of recent advances in the theory of firm behavior in two-sided markets, we show that taxation of ads may be counterproductive. In particular, we identify a number of situations in which ad-adverse consumers are negatively affected by the tax, and we even show that the tax may lead to higher ad volumes. This unorthodox reaction to a tax may arise when consumers significantly dislike ads, i.e. in situations where traditional arguments for corrective taxes are strongest.

Rethinking the Taxation of the Financial Sector

The economic crisis that erupted in 2008 has prompted many countries to rethink, and several already to reform, the taxation of financial institutions. The underlying analytical issues, however, have received almost no attention in the public finance literature. This article explores the possible purposes and broad design of distinctive tax measures for financial institutions, focusing especially on the potential role of corrective taxation, and its merits relative to traditional forms of regulation, in addressing the challenges posed by the potential failure of systemically important institutions. (JEL codes: G38, H21 and H23)

The Taxation and Regulation of Banks

The financial crisis has prompted a reconsideration of the taxation of financial institutions, with practice outstripping principle: France, Germany, the United Kingdom and several other European countries have now introduced some form of bank tax, and the U.S. administration has revived its own proposal for such a charge. This paper considers the structure, appropriate rate, and revenue yield of corrective taxation of financial institutions addressed to two externalities, consequent on excessive risk-taking, prominent in the crisis: those that arise when such institutions are simply allowed to collapse, and those that arise when, to avoid the harm this would cause, their creditors are bailed out. It also asks whether corrective taxation or a regulatory capital requirement is the better way to address these concerns. The results suggest a potential role for taxing bank borrowing, perhaps as an adjunct to minimum capital requirements, at marginal rates that rise quite sharply at low capital ratios (but are likely lower when the government cannot commit to its bailout policy), reaching levels higher than those of the bank taxes so far adopted or proposed.

International Fuel Tax Assessment: An Application to Chile

Gasoline and diesel fuel are heavily taxed in many developed and some emerging and developing countries. Outside of the United States and Europe, however, there has been little attempt to quantify the external costs of vehicle use, so policymakers lack guidance on whether prevailing tax rates are economically efficient. This paper develops a general approach for estimating motor vehicle externalities, and hence corrective taxes on gasoline and diesel, based on pooling local data with extrapolations from U.S.evidence. The analysis is illustrated for the case of Chile, though it could be applied to other countries.