Tax Policy Design Research Articles

An empirical study of the impact of corporate taxation on the global allocation of foreign direct investment: a broad tax attractiveness index approach

The question of whether a country’s corporate tax regime has a significant influence on the level of foreign direct investment (FDI) into that country is an important consideration in the design of national tax policy. This is especially relevant today in view of the recent increase in the global mobility of capital and subsequent increase in the importance of FDI to nations’ economies. Although several prior quantitative studies have investigated the link between taxation and FDI, they have tended to be restricted in geographical scope and in their measure of taxation. This study constructs indices of “corporate tax attractiveness” for selected countries and then analyses the relationship between the indices and measures of the flow of FDI into those countries. The indices are constructed by obtaining evaluations from international investors and taxation experts on the various attributes of the tax systems of those selected countries. A significant positive relationship was found to exist between the indices and measures of FDI inflows, and between individual tax system attributes and those inflows, thus adding support to the supposition that host country corporate taxation influences the size of FDI inflows.

Recent Developments in and Future Prospects for Public Economics

This paper describes several of the most important research advances in public economics during the last three decades. These include an improved theoretical understanding of the incentive problems in tax design, an expanded base of knowledge on how taxes and social insurance programs affect household and firm behavior, and a heightened recognition of the political economy of tax and expenditure policy design. The paper closes with several suggestions for promising directions for future research in the field of public economics.

The Complexity of Economic Policy: I. Restricted Local Optima in Tax Policy Design

Economists traditionally tackle normative problems by computing optimal policy, i.e. the one that maximizes a social welfare function. In practice, however, a succession of marginal changes to a limited number of policy instruments are implemented, until no further improvement is feasible. I call such an outcome a ”restricted local optimum”. I consider the outcome of such a tatonnement process for a government which wants to optimally set taxes given a tax code with a fixed number of brackets. I show that there is history dependence, in that several local optima may be reached, and which one is reached depends on initial conditions. History dependence is stronger (i.e. there are more local optima), the more complex the design of economic policy, i.e. the greater the number of tax brackets. It is also typically stronger, the greater the interaction of policy instruments with one another – which in my model is equivalent to agents having a more elastic labor supply behavior. Finally, for a given economy and a given tax code, I define the latter’s average performance as the average value of the social welfare function across all the local optima. One finds that it eventually sharply falls with the number of brackets, so that the best performing tax code typically involves no more than three brackets.

Investments in human capital, wage uncertainty, and public policy

The importance of risk characteristics of human capital for the design of tax and education policy is explored. Wages are uncertain and education, while increasing the expected wage, may increase or decrease wage variance. The government has strong reasons to encourage human capital formation in the latter case, partly due to the insurance effect of human capital, and partly due to the way the individuals—under a plausible restriction on ‘prudence’—respond to changes in risk. The analysis is illustrated using two models of education: one where education helps the individuals make better occupational choices, and a standard risk-augmented Becker-type model.

Forest Taxation and Rotation Age under Private Amenity Valuation: New Results

This paper studies the impact of harvesting, property, and profit taxes on private rotation age in an ongoing rotations model, where the private landowner is interested not only in the present value of harvest revenue, but also in the private amenity services provided by the forest stand. The main finding of the paper is that conventional wisdom about the rotation effects of forest taxes, distilled from the Faustmann model, predominantly ceases to hold. This is because forest taxes distort the relative profitability of timber and amenity production in a way that is sensitive to the precise nature of amenity valuation. Therefore, the design of forest tax policy necessitates good knowledge of the landowner's objective function concerning the type of amenity services.

Where Schumpeter was nearly right - the Swedish model and Capitalism, Socialism and Democracy<--RID="*"-->

In Capitalism, Socialism and Democracy, Joseph A. Schumpeter concluded that socialism would eventually displace capitalism in Western democracies. This would come about as a result of the superior performance of capitalism. We extract six "stylized" propositions that are essential elements of Schumpeter's prediction about the fate of capitalism. These propositions are confronted with aspects of the development of the Swedish economy. The three main results of the analysis are: (1) The evolution of the Swedish economy closely followed Schumpeter's predictions until about 1980: Large firms became increasingly predominant in production and innovative activity, ownership of firms became more and more concentrated, individual entrepreneurship waned in importance, the general public grew increasingly hostile towards capitalism, and by the late 1970s explicit proposals for a gradual transfer of ownership of firms from private hands were launched. (2) Design of tax and industrial policies fueled a development of the economy along the lines predicted by Schumpeter. In general, the policies discouraged private wealth accumulation. In particular, the policies favored concentration of firms and concentration of private ownership. (3) The turning away from the path to socialism coincides with real world developments, and have disclosed two major flaws in Schumpeter´s analysis. First, the ever more obvious failure of socialism in Eastern Europe went against Schumpeter's assertion that socialism can work. Second, Schumpeter, who thought modern technology would make the giant corporation increasingly predominant, did not foresee the revival of entrepreneurship that took place in the Western countries around 1980.

Environmental considerations in tax policy design

This paper discusses how environmental considerations will affect tax policy in the decades ahead. It argues that, in the future, interactions between tax and environmental policy are likely to go well beyond recent discussion of double divided issues, and that internalization of environmental externalities via tax policy will be the goal, which inevitably will involve the particular rather than the general. As a result, notions of neutrality which dominate current thinking on tax design will come under challenge; and in ways which will go well beyond current discussion of special treatment for particular goods and industries on environmental grounds. special treatment of environmentally harmful methods of production, more so than of goods and industries as under present tax policies, will be the name of the game. Moreover, the informational requirements of such an approach to tax policy are likely to be large. The paper concludes by pointing out that if environmental quality is a luxury good, as many suppose, with income elasticity of demand greater than one, then high income households will gain disproportionately from internalization of the externalities at issue. This may fuel pressures for more redistribution elsewhere in the tax system than is currently the case.

Designing tax policy in federalist economies: An overview

The emerging economic federations of the European Union, Russia, and South Africa, along with the established federations in Australia, Canada, and the United States, confront the task of designing the institutions for federal fiscal policy. This paper reviews the literature on the design of tax policy in federalist economies. We conclude that taxation by lower level governments can lead to significant economic inefficiencies and inequities. The usual ‘assignment’ view of federalis recommends central government policies — for example, resident-based taxation or grants-in-aid — to correct these failures. These recommendations assume that the central government will act as a benevolent social planner. The ‘political economy’ view of federalism suggests that this assumption is in error and that additional federalist institutions must be considered. Alternative legislative structures and constitutional rules are considered.

Corporate Tax Analysis in a Dominant Firm Model with Sunk Capital Investment

The design of corporate tax policy under conditions of imperfect competition in product markets is of considerable interest to policy makers, academics and practitioners. Unfortunately, few research studies on this topic have been undertaken. Theoretical and empirical results available in the public economics literature are generally obtained by assuming perfectly competitive product markets. Imperfect competition raises a number of interesting issues that do not arise under perfect competition. These include strategic interactions between firms arising from past investments, asymmetries in cost and market structure, and the differential treatment of firms. Consideration of these issues suggests that taxation may cause changes in market structure via the entry and exit of firms. When this occurs, small tax changes may induce large changes in market output and price. The present paper will address these issues by examining the impact of taxes on capital within a dominant firm model. It is organized as follows. Section II presents an overview of the model. Section III examines the effects of capital taxes and subsidies on market output and price. Section IV concludes the paper by briefly discussing the economic welfare implications of the results.

Tax Reforms and Labor Supply

The 1980s were a period of substantial changes in the U.S. tax code and income distribution. Even after controlling for demand-side factors that altered the returns to education, researchers have shown that behavioral responses to tax reform remain substantial. This paper reviews the lessons that have emerged from research on the behavioral response to tax reforms, focusing primarily on the labor supply response. The paper also builds on that work by examining whether the dramatic responses in taxable income over the 1980s are due to an increase in male labor market participation. Microdata from 1976 to 1993 are consistent with only a small male labor supply response after the Tax Reform Act of 1986. This finding is important for the interpretation of previous work and for the design of tax policy.

Uncertainty, Optimal Taxation and the Direct Versus Indirect Tax Controversy

This paper examines how the presence of uncertainty affects the design of tax policy when both indirect taxes and a general income tax are available to the government. There are two categories of goods: the consumption levels in one group are committed to before the resolution of uncertainty and those of the other after. The paper proves that, contrary to A. B. Atkinson and J. E. Stiglitz's (1976) result, differential commodity taxation remains a useful instrument of optimal tax policy even if preferences are separable between labor and produced goods. Copyright 1995 by Royal Economic Society.

Taxation and Household Saving: Reflections on the OECD Report

At the beginning of the 1990s, there was a wave of interest in the connections between taxation and saving, culminating in a series of reports and reviews in 1994. So, for example, UK tax policy towards saving and investment has been reviewed in the context of the Industrial Finance Initiative; Finance Ministers had an extensive discussion at the IMF meeting in Madrid; under the German presidency of the EU, work has continued on a possible common basis for taxing savings, as initiated by Belgium last year; the IFS Capital Taxes Group concluded its deliberations with Proposals for the Taxation of Savings and Profits; and in the August issue of Fiscal Studies, Boadway and Wildasin surveyed much of the literature from the 1980s. Then in November the OECD published an extensive survey on Taxation and Household Saving in each of its 24 Member countries in 1993, together with an analysis of what lessons might be learned for good design of tax policy from the literature and country experiences. This article summarises the report and considers what might be deduced from its conclusions.

The Theory and Practice of Tax Reform in Developing Countries.

This 1991 study approaches the subject of tax reform from basic economic principles. The objectives are to develop guidelines for the design of tax policy; to show how the principles can structure systematic research into tax reform in terms of the consequences for households, producers and government; and finally, to combine the guidelines and applied research into a practical tax package for Pakistan. Professors Ahmad and Stern provide a coherent framework to show how principles can be formulated, applied research structured, and policies developed and appraised in a systematic manner. This book will be useful to graduate students, academic economists, and professional economists in international organisations and governments interested in public policy and development planning. The careful application of the ideas presented here should lead to a real improvement in the development of policy and to further empirical and theoretical research.

Hierarchical design and enforcement of income tax policies

A hierarchical model of tax compliance is studied in which the government selects a tax policy and then delegates the responsibility to collect taxes to the IRS. There is a fixed distribution of income in the economy. Individuals differ by their income, which is known niether to the government nor to the IRS. We completely characterize the solution to the IRS's revenue-maximizing problem. When taxpayers are risk neutral, the optimal auditing policy divides the reported incomes into at most three groups. We show that the government provides a smaller budget to the IRS than the IRS would wish.

On the optimal income taxation and educational decisions

In this paper we consider three different ways of incorporating individuals' educational choices into the design of optimal income tax policy. In one variant of the model (case 2), where an individual chooses his education before knowing his ability and after that education makes his labour supply decisions on the basis of known ability, it is shown that qualitative features of the optimal income tax schedule are not similar to those of the standard optimal income tax model. The marginal tax rate is generally not zero at the endpoints of distribution but is most likely negative. Using numerical methods, some interesting features quite different from earlier numerical results are revealed, especially in the second case. For example, the marginal tax rate is non-decreasing in income for a substantial income range. In addition, our calculations support neither the traditional views on the egalitarian nature of equal education nor its disadvantageous consequences in the perfect utilitarian society.