Higher Income Tax Research Articles

Taxing Capital? Not a Bad Idea After All!

We quantitatively characterize the optimal capital and labor income tax in an overlapping generations model with idiosyncratic, uninsurable income shocks and permanent productivity differences of households. The optimal capital income tax rate is significantly positive at 36 percent. The optimal progressive labor income tax is, roughly, a flat tax of 23 percent with a deduction of $7,200 (relative to average household income of $42,000). The high optimal capital income tax is mainly driven by the life-cycle structure of the model, whereas the optimal progressivity of the labor income tax is attributable to the insurance and redistribution role of the tax system. (JEL E13, H21, H24, H25)

Government Size and Unemployment: Evidence from Industrial Countries

Using data from 19 industrial countries for the period 1985 to 2002, this paper analyzes how the size of the government sector affects unemployment. Controlling for the impact of the business cycle as well as for the impact of all major labor market institutions and unobserved country effects, we find that a large government sector is likely to increase unemployment. It appears to have a particularly detrimental effect on women and the low skilled and to substantially increase long-term unemployment. It seems that dominant stateowned enterprises, a large share of public investment in total investment as well as high top marginal income tax rates and low income threshold levels at which they apply are particularly detrimental.

An Efficiency Analysis of Proposed State and Local Sales Tax Reforms

With few exceptions, state and local general sales and use taxes are levied primarily on tangible goods. Secular trends in production and consumption of goods and services, as well as legislated exemptions and exclusions, have eroded sales tax bases. A number of reforms designed to reduce base erosion have been proposed, including base broadening, conversion to a consumption tax, and wholesale replacement of sales taxes with income taxes. Each proposal has potential to shore up sales tax bases. From an economic perspective, the policy choice should turn on efficiency, equity, and simplicity. This paper reports on a computer analysis of efficiency effects. The results suggest that (i) base broadening can increase economic efficiency, (ii) converting to a consumption tax base dominates base broadening, (iii) replacing sales taxes with higher income taxes could produce large efficiency losses, (iv) base broadening could generate efficiency gains even if untaxed remote sales become a “sizable” fraction of total sales, and (v) even partial base broadening could produce sizable efficiency improvements.

Employee Stock Options and Taxes

In this paper, we investigate the effect of stock options on the tax position of the firm. We argue that option tax deductions can significantly affect a firm's marginal tax rate and that the effect is masked by current financial reporting rules. We present an approach for factoring in option deductions in assessing a firm's tax position and document that the effect can be substantial. In particular, many firms that appear to be profitable and face high income tax burdens (based on public financial statement data) actually pay relatively little in taxes. We provide evidence that the effect of options on taxes may help to explain managerial decisions such as why apparently profitable firms carry so little debt, lease rather than purchase, and out-source tax-advantaged activities, such as research and development, to syndicated partnerships.

Paying after Graduation: An Empirical Assessment of Loans with Income Forgiveness and Human Capital Contracts

There are many arguments supporting greater private contribution to higher education costs, particularly in Europe. But this case largely rests on the capability to offer deferred, income-contingent payments and to pool the cost of income contingency among all graduates. The two first features are critical to efficiency - students and lenders should not be deterred by excessive risk - and justice - contributions should be tailored to ex post ability to pay. While cost pooling is essential to avoid public debt classification of student contracts. Examples of instruments satisfying these criteria are loans with income-forgiveness and human capital contracts. The central aim of this paper is to produce realistic estimates of how graduates' lifetime earnings are likely to be affected by the generalisation of these instruments. Using data on Belgian wages, we compute estimates of contributions that these instruments could impose on graduates. We also evaluate their effect on population-wide distribution of lifetime net wages, using higher income tax as a benchmark. The paper further considers the risk of adverse selection inherent to cost pooling. It shows that investing less on students opting for less profitable programs is a simple way to mitigate its severity.

Pensions and Insider-Outsider Unemployment

If workers gain an insider position through past activity, young workers will bear the resulting outsider unemployment burden. In a world where productivity of employed workers rises because of learning-by-doing, and where labor demand is sufficiently elastic, preventing this unemployment (by lowering wages) leads to a higher income tax base in the future. Thus the institution of certain intergenerational transfer schemes provides an incentive for insiders to lower wages. In a stylized overlapping-generations model I show that this effect partially or fully abolishes unemployment in the steady-state equilibria.

The effects of regional migration on gross income of labour in Sweden

Abstract. In this article we study the effect of interregional migration on gross income of labour. The empirical analysis is based on Swedish household data for the period 1994 to 1995. We are primarily concerned with the allocation effect of migration on economic growth in an economy where the incentives for migration may be hampered by relatively high income taxes and transfers. A treatment‐effect model for migration and income is estimated. The results indicate significant income gains from migration for the unemployed as well as for those who were employed prior to migration. The estimation results also indicate negative correlation between errors in the migration function and the income function. The hypothesis of no self‐selection can be rejected.

Economic Effects of Taxing Different Organizational Forms under the Nordic Dual Income Tax

This paper analyzes the economic effects of income splitting rules for closely held corporations and sole proprietorships/partnerships under the Nordic dual income tax. Income is split by imputing a return to capital, but the methods used for this differ between the Nordic countries. With a few notable exceptions, income splitting does well in the sense that the cost of capital is approximately the same in closely and widely held corporations. The special tax rules for sole proprietorships/partnerships manage to neutralize the impact of the high labor income tax on the cost of capital.

Foreign direct investment in a world of multiple taxes

Governments impose multiple taxes on foreign investors, though studies of the effect of tax policy on the location of foreign direct investment (FDI) focus almost exclusively on corporate income taxes. This paper examines the impact of indirect (non-income) taxes on FDI by American multinational firms, using affiliate-level data that permit the introduction of controls for parent companies and affiliate industries. Indirect tax burdens significantly exceed the foreign income tax obligations of foreign affiliates of American companies. Estimates imply that 10% higher local indirect tax rates are associated with 7.1% lower affiliate assets, which is similar to the effect of 10% higher income tax rates. Affiliate output falls by 2.9% as indirect taxes rise by 10%, while higher income taxes have more modest output effects. High corporate income tax rates depress capital/labor ratios and profit rates of foreign affiliates, whereas high indirect tax rates do not. These patterns reveal the impact of indirect taxes and suggest the mechanisms by which direct and indirect taxes affect FDI.

Distributional Implications of Environmental Taxation in Denmark

AbstractEnvironmental taxes have been introduced in many countries. However, few countries have reached the level of environmental taxation that is seen in Denmark today. This paper analyses the individual taxes as well as the combination of all these taxes and duties related to environmental concerns, including taxes on heating, transport fuels, electricity, water, waste, plastic bags, registration of cars, annual car use and pesticides.The distributional effect of taxes is examined in relation to household income, socio‐economic class, residential location and family status. The shifting of the tax structure from high marginal income tax to consumption‐based taxes, especially environmental taxes, might have distributional impacts that have not been considered part of the tax policy.The results suggest that in Denmark taxes on petrol and registration duties for cars are progressive, whereas most other environmental taxes are regressive, especially the green taxes on water, retail containers and CO2 emissions.

Sweden

Sweden is one of the largest countries in Europe but has one of the smallest populations – nine million people. Because Sweden did not participate in the Second World War,...

Notes from the Editors, March 2003

» Notes from the EditorsIn the 1920s Andrew Mellon, who served as secretary of the treasury under Presidents Harding, Coolidge, and Hoover (it was sometimes said that they served under him), introduced a series of gargantuan tax cuts culminating in what was known as the Mellon Plan. This consisted of a huge cut in the income tax rates of the rich along with reductions in other taxes paid by the wealthy. High income tax rates, Mellon claimed, “tend to destroy individual initiative and enterprise and seriously impede the development of productive enterprise.” When Mellon’s foes, such as the great Progressive Senator Robert La Follette, declared that Mellon was trying to “let wealth escape” its fair share of taxation, he sought to turn the tables on them by charging that they were engaging in class warfare. “The man who seeks to perpetuate prejudice and class hatred,” the treasury secretary stated, “is doing America an ill service. In attempting to promote or defeat legislation by arraying one class of taxpayers against another, he shows a complete misconception of the principles of equality on which the country was founded” This article can also be found at the Monthly Review website, where most recent articles are published in full.Click here to purchase a PDF version of this article at the Monthly Review website.

Capital Gains and the Alternative Minimum Tax

The author explores the interrelationship among long-term capital gains, state income tax rates, and the likelihood that the alternative minimum tax will apply. Given a large proportion of long-term capital gains, an individual investor will find himself subjected to the federal alternative minimum tax, despite the fact that long- term capital gains receive favorable tax treatment for purposes of that tax. This conclusion is particularly applicable if the investor resides in a state which has a high state income tax rate. By considering only those variables that are directly related to taxable income, a formula can be developed which determines the proportion of long-term capital gains at which the alternative minimum tax will apply, and calculates that proportion as a function of state income tax rates. This formula provides investors with a means of determining, in a timely manner, whether they will be subject to the alternative minimum tax, so that appropriate timing and planning of taxable transactions can be performed. The author concludes by suggesting several planning alternatives to mitigate this problem, which will only become more significant in future years as federal individual tax rates decline while the alternative minimum tax rate remains unchanged.

Power-law Distribution of High Income Taxes in Japan

Power-law Distribution of High Income Taxes in Japan

Taxes, economic conditions and recent trends in male self-employment: a Canada–US comparison

North American workers have increasingly turned to self-employment since the 1970s. Using microdata for the period 1983–1994 from Canada and the United States, I assess the importance of macroeconomic conditions and the tax environment in explaining the trends in male self-employment in these two countries. My findings suggest that higher income tax and unemployment rates are associated with an increase in the rates of self-employment among North American men. Changes in the tax environment account for a considerable amount of the secular trends in male self-employment over this period, while changing economic conditions played a smaller role in determining these trends.

Financial repression and external openness in an endogenous growth model

An endogenous growth model has been developed that extends Sidrauski (1967), Roubini and Sala-i-Martin (1992,1995) and Lucas (1988) by combining financial development, human capital investment, and external openness. Financial development and trade liberalization are shown to increase the economic growth rate by increasing the marginal benefits of human capital investment. Expansionary governments are, however, provided with an incentive to increase the money supply growth rate, to repress the financial sector, to close its economy, and to impose a high proportional income tax rate.

Integrating environmental taxes on local air pollutants with fiscal reform in Hungary: Simulations with a computable general equilibrium model

This paper describes the Fiscal Environmental Integration Model (FEIM) and its use to examine the merits of introducing a set of air pollutant emission taxes and stringent abatement requirements based on best commonly available control technology. These environmental protection strategies are examined both independently and in combination. In addition, Hungary has very high VAT, employment, and income tax rates and therefore might receive more than the usual advantage from using environmental tax revenues to reduce other taxes. We therefore also examine the economic and environmental implications of different uses of the revenues generated by the air pollutant emission taxes. FEIM is a CGE model of the Hungarian economy that includes sectoral air pollution control costs functions and execution options that allow examination of the key policy choices involved. We developed and ran a baseline and seven scenarios with FEIM. The scenarios centered on introduction of environmental load fees (ELF) on emissions of SO2, NOx, and particulates and emission abatement requirements (EAR) for these pollutants.

Employment and Wages in the Private and Local Government Sectors in a Centralized Fiscal System

This paper discusses the interaction between the local government and private sector in an institutional context consistent with a centralized fiscal system. Under decentralized wage setting in the private sector, the effects of shocks in the two sectors depend on whether private and local public goods are substitutes or complements in the union utility function. Higher wage markup in the local government sector unambiguously decreases government output while the effect on private sector employment is ambiguous. Higher income taxes have ambiguous effects on local government output. Shocks in the private sector can be reinforced through feedback effects from the local government sector. A shift from decentralized to centralized wage setting in the private sector reduces wages and increases employment in both sectors.

How Firms Make Capital Expenditure Decisions: Financial Signals, Internal Cash Flows, Income Taxes and the Tax Reform Act of 1986

This paper empirically assesses the determinants of future net capital expenditures for a broad cross-section of COMPUSTAT firms from 1973 to 1989. We explore three general categories of factors expected to affect investment: (1) external equity financing, (2) internally generated accounting information, and (3) tax incentives. We find that external financing and information plays a role in that both positive stock returns and equity issuances indicate future increases in investment. The results suggest that high stock prices not only lower the cost of capital, but also signal good investment opportunities. Accounting information about internal sources and uses of funds are also important in the investment decision. In particular, net income and depreciation are positive indicators of future investment while there is a tradeoff between the payment of dividends and investment. Further, positive changes in available cash liquidity also motivate future investment. While taxes are not important in the investment decision on average, we find that firms with previously higher income taxes invested substantially more in 1985 and 1986. This coincides with the repeal of the investment tax credit and the accelerated depreciation schedules in the Tax Reform Act of 1986. We view this as evidence that federal tax policy in the 1980's induced firms with high income tax obligations to accelerate capital expenditures just before the favorable tax treatment of capital expenditures was eliminated.

Tax advice to developing countries: An historical survey

The tax policy advice given to developing countries by foreign experts has been influenced by changing public finance doctrines, development theory and policy, and practices and debates in industrial countries. Current tendencies include less emphasis than formerly on taxation to mobilize savings in accordance with a national plan, to reduce inequality, and to influence resource allocation by special incentives. Governments are advised to avoid interfering with market-directed allocations of resources, high and progressive income tax rates, high import duties, and export taxes. A value-added tax is recommended for middle-income countries.