Labor Income Tax Research Articles

Motivation to Work, Labor Income Taxes and Life Satisfaction: Hungary, Estonia, Continental Europe and the United States

Abstract The primary findings of this paper are that the increase in hours worked per employee comes at the expense of life satisfaction, and differences in labor income taxes cannot account for differences in time allocation. Once life satisfaction is included, the hypotheses of previous neoclassical economic studies is almost irrelevant in determining the response of market hours to higher taxes. We find a negative relationship between hours worked across countries and life satisfaction. In the countries with the highest hours worked (Hungary, Estonia), leisure is generally preferred to wealth and in the lowest hours worked (France, Germany), wealth is preferred to leisure.

Well-Being, Poverty and Labor Income Taxation: Theory and Application to Europe and the U.S

We study a model in which agents dier in their productive skills and their preferences over labor time/consumption bundles. We assume there is a poverty line, that is, there is a minimal level of consumption below which society nds it unacceptable to let people live. To avoid conict with individual well-being, we capture the anti-poverty project be requiring redistribution to take place between agents on both sides of the poverty line provided they have the same labor time. We combine this requirement with eciency

Taxation and Incentives to Innovate: A Principal-Agent Approach

A principal-agent model with multiple job tasks is used to explore the effects of different tax schemes on innovation in a pure knowledge economy with bootleg innovation. Corporate taxes and labor income taxes can affect both the firm owner's and the employee's incentives to commit to innovative tasks, when the former compensates the latter (a manager or a technical or R&D employee) by means of variable pay tied to measures of the company's success. Results point to complementary roles between patent-box tax incentives and reductions in the tax rate levied on profit-sharing schemes, and they show that a revenue-neutral reform substituting the latter for the former is always possible. The complementarity holds, albeit with different relative importance for the two tax incentives, also with nondeductible labor costs and with a stochastic innovation value coupled with a risk-averse agent.

The Design of Fiscal Reform Packages: Insights from a Theoretical Endogenous Growth Model

This paper studies the impact on growth, welfare, and government debt of fiscal reform packages in a theoretical model drawing together three key features of the endogenous growth literature: (i) investment in technology (in the form of human capital) offsets diminishing marginal productivity of private capital, allowing for perpetual growth in output per capita; (ii) changes in investment behavior because of cuts to distortionary tax rates impact long-run growth; and (iii) public capital has a role influencing total factor productivity and growth. A quantitative simulation using reasonable parameter values suggests that modest capital and/or labor income tax cuts and public investment increases have significant positive effects on consumer welfare but small effects on per capita income growth, where fiscal costs are offset by reductions in unproductive government spending. Capital income tax cuts and public investment increases continue to boost welfare when offset by consumption tax rises (rather than spending cuts), although the welfare benefits of modest labor income tax cuts are outweighed by the costs of a compensating consumption tax increase.

Public Pensions in a Multi-Period Mirrleesian Income Tax Model

Using an OLG model with skill uncertainty and private savings, we investigate whether an optimally designed set of public pension transfers can usefully supplement a nonlinear labor income tax as a ...

The Design of Fiscal Reform Packages: Insights from a Theoretical Endogenous Growth Model

This paper studies the impact on growth, welfare, and government debt of fiscal reform packages in a theoretical model drawing together three key features of the endogenous growth literature: (i) investment in technology (in the form of human capital) offsets diminishing marginal productivity of private capital, allowing for perpetual growth in output per capita; (ii) changes in investment behavior because of cuts to distortionary tax rates impact long-run growth; and (iii) public capital has a role influencing total factor productivity and growth. A quantitative simulation using reasonable parameter values suggests that modest capital and/or labor income tax cuts and public investment increases have significant positive effects on consumer welfare but small effects on per capita income growth, where fiscal costs are offset by reductions in unproductive government spending. Capital income tax cuts and public investment increases continue to boost welfare when offset by consumption tax rises (rather than spending cuts), although the welfare benefits of modest labor income tax cuts are outweighed by the costs of a compensating consumption tax increase.

Cross-base tax elasticity of capital gains

ABSTRACTThis paper studies the cross-base tax elasticity of capital gains realizations to labour income taxes when capital gains are taxed at a separate proportional tax rate. Using a longitudinal panel of over 265 000 individuals in Sweden, this paper shows in a regression kink design that labour income taxes affect capital gains realizations in two ways. An increase in the marginal labour income tax rate increases the likelihood of realizing capital gains and the amount of realized capital gains. One implication of this result is that labour income taxes have a lock-out effect but that the magnitude of this effect is smaller than the lock-in effect of the actual capital gains tax.

Optimal commodity taxation with varying quality of goods

A standard result in the optimal taxation literature is that when agents differ in market ability and the government aims at redistributing from high- to low-skilled agents by means of an optimal nonlinear labor income tax and a set of commodity taxes, an optimally designed commodity tax structure should encourage (discourage) the consumption of goods/services that are complement with labor (leisure). In this paper we highlight that when agents can choose both the quality and the quantity of a given good/service, this standard commodity tax result needs to be qualified. First, we show that it becomes relevant to distinguish between specific and ad valorem taxes/subsidies. Second, whether the standard result holds or not depends on how the concept of labor (leisure) complement is defined, namely, whether it is defined in terms of number of units or in terms of expenditure. We also show that levying specific and ad valorem taxes at opposite signs on a given good can be a feature of the second-best optimum.

Taxing Capital? The Importance of How Human Capital is Accumulated

This paper considers the impact of how human capital is accumulated on optimal capital tax policy in a life cycle model. In particular, it compares the optimal capital tax when human capital is accumulated exogenously, endogenously through learning-by-doing, and endogenously through learning-or-doing. Previous work demonstrates that in a simple two generation life cycle model with exogenous human capital accumulation, if the utility function is separable and homothetic in each consumption and labor, then the government has no motive to condition taxes on age or tax capital. In contrast, this paper demonstrates analytically that adding either form of endogenous human capital accumulation creates a motive for the government to use age-dependent labor income taxes. Moreover, if the government cannot condition taxes on age, then a capital tax can be optimal in order to mimic such taxes. This paper quantitatively explores the strength of this channel and finds that, includ ing human capital accumulation with learning-by-doing, as opposed to exogenously, causes the optimal capital tax to increase by between 7.3 and 14.5 percentage points. In contrast, introducing learning-or-doing causes a much smaller increase in the optimal capital tax of between 0.7 and 3.7 percentage points. Taken as a whole, this paper finds that the specific formulation by which human capital is accumulated can have notable implications on the optimal capital tax.

Does expansion of higher education lead to trickle-down growth?

The paper revisits the debate on trickle-down growth in view of the widely discussed changes in the distribution of earnings and income that followed a massive expansion of higher education. We propose a dynamic general equilibrium model to dynamically evaluate whether economic growth triggered by an increase in public education expenditure on behalf of those with high learning ability eventually trickles down to low-ability workers and serves them better than redistribution through labor income taxation or education policies targeted to the low-skilled. Our results suggest that promoting higher education implies that low-skilled workers first lose in terms of consumption and income but eventually gain. Policies that aim at expanding the skills of low-ability workers make them better off only moderately because of adverse general equilibrium effects. Low-ability workers typically benefit most from redistribution.

Beyond the labour income tax wedge: the unemployment-reducing effect of tax progressivity

In this paper, we argue that, for a given overall level of labour income taxation, a more progressive tax schedule increases employment. From a theoretical point of view, higher progressivity increases overall employment through a wage moderating effect and also because employment of low-paid workers is more elastic to wages. We test these theoretical predictions on a panel of 21 OECD countries over 1998–2008. Controlling for the burden of taxation at the average wage, our estimates suggest that a more progressive tax schedule reduces the unemployment rate and increases the employment rate. These findings are confirmed when we account for the potential endogeneity of both average taxation and progressivity. Overall, our results suggest that policy-makers should not only focus on the detrimental effects of tax progressivity on in-work effort, but also consider the employment-enhancing effects.

Comparing the Effects of Discretionary Tax Changes between the US and the UK

The remarkable similarities of the effects of discretionary tax changes between the US and the UK, shown in Cloyne (2013), raise the obvious concern whether the effects of tax changes at disaggregated levels in the UK still resemble those in the US. This paper investigates the issue along three dimensions -- positive and negative tax changes, anticipated and unanticipated tax changes, and capital and labor income tax changes. We show the impacts of various types of tax changes between the two countries differ in their directions, magnitudes and timings.

The development of universal health insurance coverage in Thailand: Challenges of population aging and informal economy

This paper quantitatively investigates the sustainability of the universal health insurance coverage (UHI) system in Thailand while taking into account the country's rapidly aging population and large informal labor sector. We examine the effects of population aging and informal employment across three tax options for financing the UHI. A modern dynamic general equilibrium framework is utilized to conduct policy experiments and welfare analysis. In the case of labor income tax being used to finance the cost of UHI, an additional 11–15% of labor tax will be required with the 2050 population age structure, compared with the 2005 benchmark economy. We also find that an expansion of income tax base to the informal sector can substantially alleviate the tax burden. Based on welfare comparisons across the alternative tax options, the labor income tax is the most preferred because the inequality between formal/informal sectors is large. If the informal sector cannot avoid labor income tax, capital tax will be preferred over labor and consumption taxes.

Impacts of Universal Health Coverage: A Micro-Founded Macroeconomic Perspective

This paper studies the impact of tax-financed universal health coverage schemes on macroeconomic aspects of labor supply, asset holding, inequality, and welfare, while taking into account features common to developing economies, such as informal employment and tax avoidance, by constructing a dynamic stochastic general equilibrium model with heterogeneous agents. Agents have different education levels, employment statuses, and idiosyncratic shocks. Given three tax financing options, calibration results suggest that the financing options matter for outcomes both at the aggregate and disaggregate levels. Universal health coverage, financed by labor income tax revenue, could reduce inequality due to its large redistributive role. Social welfare cannot be improved when labor decisions are endogenous and distortions are higher than the redistributive gains for all tax financing options. In the absence of labor supply choice, mild welfare gains are found.

Every Cloud Has a Silver Lining. The Sovereign Crisis and Italian Potential Output

This paper evaluates the direct and indirect effects of the sovereign debt crisis on Italy’s potential output. The direct effects are captured by the increase in the interest rate paid by Italian borrowers in the second half of 2011, the indirect effects by the policy responses to the crisis (fiscal consolidation and structural reforms). Using a New Keynesian dynamic general equilibrium model, we compute potential output as the “natural” level of output in the absence of nominal price and wage rigidities. The evaluation posits a no-crisis scenario in line with the pre-2011 potential output projections and government budget rules. We find first that the fiscal and financial shocks that caused the 2011-2013 recession subtracted 1.6 percentage points from potential output growth, while the structural reforms in 2013 have limited the reduction in output capacity to about 1.4 points; second, that the structural reforms have a long-run growth-enhancing impact on potential output of around 3 points from now to 2030; and third, that once budget balance is achieved in the medium term (2019), reductions in either labor or capital income taxes would boost potential output growth by about 0.2 points per year.

Relative consumption of housing: Marginal saving subsidies and income taxes as a second-best policy?

This paper analyzes whether marginal taxation of labor and capital income are useful second best instruments for internalizing the externalities caused by conspicuous housing consumption, when the government is unable to implement a first best corrective tax on housing wealth. The rationale for studying income taxation in this particular context is that first best taxes on housing wealth may be infeasible (at least in a shorter time perspective), while income taxes indirectly affect both the level and composition of accumulated wealth. We show that a suboptimally low tax on housing wealth provides an incentive for the government to subsidize financial saving and tax labor income at the margin.

Price Stability in Economies with Habit Persistence

This paper shows that the divine‐coincidence does not hold in a sticky price model with external habit if a time‐varying tax rate on labor income is not implemented to fully eliminate the time‐varying distortions associated with external habit and monopoly power in goods market. The required labor income tax rate is inversely related to the risk‐free real interest rate and the markup in the goods market, but it is proportional to the degree of external habit. Under this circumstance, the optimal monetary policy commands a countercyclical interest rate, having a perfect negative correlation with tax rate in the sticky price model with external habit. If a time‐invariant tax is the only fiscal instrument, then the degree of external habit entails a gap between the private marginal rate of substitution between consumption and labor and the social marginal rate of substitution, generating an endogenous trade‐off between the stabilization of welfare‐relevant output gap and inflation. Under this circumstance, price stability is not the optimal policy. The monetary policy authority should optimally try to undo the time‐varying distortions associated with external habit and monopoly power in goods market by deviating from price stability.

Probabilistic Lump-Sum Taxation

In this paper, we describe an elementary, fully implementable, and revenue neutral randomizing mechanism that leads to a Pareto improvement over allocations induced by labor income tax functions. We illustrate, by providing a theoretical example, that our mechanism can be applied to optimal tax functions identified by Saez and Diamond. Furthermore, we provide an explicit numerical example, which confirms that our procedure can lead to a Pareto improvement over allocations induced by optimal tax functions of Mirrlees. Moreover, we show that our randomizing procedure is not only implementable, as it requires less than the standard informational demands, but can also lead to sizable welfare gains amounting to about 10% of the underlying distortion. Finally, we show that, unlike most of the traditional approaches involving randomness, the mechanism we describe can preserve horizontal equity.

EFFECTS OF PERMANENT AND TRANSITORY TAX CHANGES IN A LIFE‐CYCLE LABOR SUPPLY MODEL WITH HUMAN CAPITAL

I examine effects of labor income taxation in life‐cycle models with human capital accumulation. In this case, the opportunity cost of time equals the wage plus returns to work experience. This has several interesting consequences: First, the data appear consistent with larger labor supply elasticities than prior work suggests. Second, contrary to conventional wisdom, permanent tax changes can have larger effects on current labor supply than temporary changes. Third, human capital dampens responses of young workers to transitory tax changes. Fourth, labor supply elasticities increase with age. Fifth, human capital amplifies the effect of permanent tax changes in the long run.

Fiscal reform and government debt in Japan: A neoclassical perspective

Past government spending in Japan is imposing a significant fiscal burden that is reflected in a net debt to output ratio near 150%. In addition, an aging Japanese society implies that public expenditures and transfers payments relative to output are projected to continue to rise until at least 2050. In this paper we use a standard growth model to measure the size of this burden in the form of additional taxes required to finance these projected expenditures and to stabilize government debt. The fiscal adjustment needed is very large, in the range of 30–40% of total consumption expenditures. Using a distorting tax such as the consumption tax or the labor income tax requires either tax to rise to unprecedented highs, although the former is much less distorting than the latter. The extremely high tax rates we find highlight the importance of considering alternatives that attenuate the projected increases in public spending and/or enlarge the tax base.