Labor Income Tax Research Articles

Closing the 49th Parallel: An Unexplored Episode in Canadian Economic and Political History

We draw attention to, and begin to consider the implications of, the severe restrictions on emigration by Canadians to the United States introduced under the US Immigration Act of 1965. These restrictions came into effect in 1968 and lasted until mobility began to increase to some extent under the free trade agreements in the early 1990s. This is an unusual episode in Canadian history, the implications of which for the Canadian economy and for Canadian public policy appear to have received little attention. We assemble evidence that suggests that the near closing of the border led toward uncoupling of Canadian and US labour markets and to a decrease in the elasticity of labour supply in Canada. Implications for Canadian fiscal policy of a decline in labour elasticity are then derived using a model of equilibrium fiscal structure. We show that these predictions, including heavier taxation of labour income and an increase in the overall size of the public sector, are consistent with what occurred over the two decades after the near closing of the US border, as well as with the partial reopening following the free trade agreements. The analysis continues by acknowledging additional factors that determine the structure and size of the public sector, and by considering the near closing of the border in a broader historical context. We conclude with a prediction about the future course of Canada-US migration policy that follows from our analysis.

Optimal tax progressivity in unionised labour markets: What are the driving forces?

In labour markets with collective wage bargaining higher progressivity of the labour income tax creates a trade-off. On the one hand, wages are lowered and unemployment decreases, on the other hand, the individual labour supply decision is distorted at the hours-of-work margin. The optimal level of tax progressivity within this trade-off is determined using a numerical general equilibrium model with imperfect competition on the goods market, collective wage bargaining and a labour-supply module calibrated to empirically plausible elasticity values. The model is calibrated to macroeconomic and institutional parameters of both the OECD average and a number of individual OECD countries. In most cases the optimal degree of tax progressivity is below the actual level. A decomposition approach shows that the optimal level is increased by high unemployment and by the general tax level.

Taxation without commitment

This paper considers a Ramsey model of linear capital and labor income taxation in which a benevolent government cannot commit ex-ante to a sequence of policies for the future. In this setup, if the government is forced to keep budget balance in every period, then it may not be able to sustain zero capital taxes in the long run, as shown in Benhabib and Rustichini (J Econ Theory 77:231–259, 1997) and Phelan and Stachetti (Econometrica 69:1491–1518, 2001). However, (Dominguez in J Econ Theory 135:159–170, 2007) shows that if the government is allowed to borrow and lend to households, the optimal capital income tax still converges to zero in the long run, as long as the value of defaulting is independent of the level of government debt. This paper provides a game theoretic setup with government debt where the value of the worst equilibrium only depends on the initial level of capital and can be determined in advance. This implies that under our assumptions the best sustainable equilibrium has zero capital taxes in the long run, even in the absence of government commitment.

Human Capital, Taxes and Labour Supply

The standard life‐cycle labour supply model accounts for asset accumulation, but ignores human capital investment. This article describes some recent work that introduces human capital into the standard model. This has some interesting, and even surprising, implications for labour supply elasticities. In particular, once we account for the effects of human capital, it appears that labour supply elasticities may be much larger than conventional wisdom would suggest. This, in turn, implies that the efficiency costs of labour income taxation may be much larger than is commonly assumed. Consequently, labour income taxation should be viewed as comparably costly to other types of taxation (such as capital income taxation).

The Surprising Power of Age-Dependent Taxes

This paper provides a new, empirically driven application of the dynamic Mirrleesian framework by studying a feasible and potentially powerful tax reform: age-dependent labour income taxation. I show analytically how age dependence improves policy on both the intratemporal and intertemporal margins. I use detailed numerical simulations, calibrated with data from the U.S. Panel Study of Income Dynamics, to generate robust policy implications: age dependence (1) lowers marginal taxes on average and especially on high-income young workers and (2) lowers average taxes on all young workers relative to older workers when private saving and borrowing are restricted. Finally, I calculate and characterize the welfare gains from age dependence. Despite its simplicity, age dependence generates a welfare gain equal to between 0·6% and 1·5% of aggregate annual consumption, and it captures more than 60% of the gain from reform to the dynamic optimal policy. The gains are due to substantial increases in both efficiency and equity. When age dependence is restricted to be Pareto improving, the welfare gain is nearly as large.

Targeted savings and labor supply

Substantial evidence suggests that savings behavior may depart from neoclassical optimization. This article examines the implications of raising the savings rate—whether through social security, retirement plans, or otherwise—for labor supply, where labor supply is determined by behavioral utility functions that reflect the non-neoclassical character of savings behavior. Under one formulation, raising the targeted savings rate increases labor supply regardless of the slope of the labor supply curve; under a second, raising the targeted savings rate has the same effect on labor supply as that of raising the labor income tax rate; and under a third, raising the targeted savings rate has no effect on labor supply. Effects on labor supply are particularly consequential because of the significant preexisting distortion due to labor income taxation.

Globalisation squeezes the public sector—is it so obvious?

It is widely perceived that globalization squeezes public sector activities by making taxation more costly. This is attributed to increased factor mobility and to a more elastic labour demand due to improved scope for relocation of production, and thus employment across countries. We argue that this consensus view overlooks that gains from trade unambiguously work to lower the marginal costs of public funds. Moreover, we argue that a more elastic labour demand may actually reduce the marginal costs of labour income taxation and that globalization may actually reduce the labour demand elasticity.

Taxes, Tuition Fees, and Education for Pleasure

AbstractThe fact that education provides both a productive and a consumptive (nonproductive) return has important and, in some cases, dramatic implications for optimal taxes and tuition fees. Using a simple model, we show that when the consumption share in education is endogenous and tuition fees are unconstrained, the optimal tax/fee system involves regressive income taxes and high tuition fees. A progressive labor income tax system may, on the other hand, be a second‐best response to politically constrained, low tuition fees. Finally, the existence of individuals with different abilities will also move the optimal income tax system toward progressivity.

UK World War I and interwar data for business cycle and growth analysis

This article contributes new time series for studying the UK economy during World War I and the interwar period. The time series are per capita hours worked and average capital income, labor income, and consumption tax rates. Uninterrupted time series of these variables are provided for an annual sample that runs from 1913 to 1938. We highlight the usefulness of these time series with several empirical applications. The per capita hours worked data are used in a growth accounting exercise to measure the contributions of capital, labor, and productivity to output growth. The average tax rates are employed in a Bayesian model averaging experiment to reevaluate the Benjamin and Kochin (J Political Econ 87:441–478, 1979) regression.

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Does tax policy affect executive compensation? Evidence from postwar tax reforms

The trends in executive pay and labor income tax rates since the 1940s suggest a high elasticity of taxable income with respect to tax policy. By contrast, the level and structure of executive compensation have been largely unresponsive to tax incentives since the 1980s. However, the relative tax advantage of different forms of pay was small during this period. Using a sample of top executives in large firms from 1946 to 2005, we also find a small short run response of salaries, qualified stock options, and bonuses paid after retirement to changes in tax rates on labor income — even though tax rates were significantly higher and more heterogeneous across individuals in the first several decades following WWII. We explore several potential explanations for the conflicting impressions given by the long-run and short-run correlations between taxes and pay, including changes in social norms and concerns about pay equality.

On the Importance of the Tax System in Marginal Cost of Funds Calculations

Abstract Several papers have attempted to derive computable analytical formulas for the Marginal Cost of Funds (MCF). However, this literature is often cast in the pure labor supply general equilibrium model, which is not completely consistent with real tax systems where Labor Income Taxation (LIT) is not the only instrument used by governments. Hence, we explicitly introduce Value-Added Taxation (VAT) on consumption goods in the conventional model, and we derive an analytical formula for the MCF which does incorporate general equilibrium interactions between the different tax bases. Then, we illustrate how much this matter for empirical estimates of MCF using French data. Our numerical example suggests that, when computing MCF for a LIT reform, taking account of the impact of LIT reform on tax revenue from VAT can make a great deal of difference, typically increasing MCF and accounting for around 0.2 to 0.8 of estimates. In addition, MCF is then really less likely to be less than one than in the conventional framework.

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Tax Policy and Employment: How Does the Swedish System Fare?

This paper reviews the literature on optimal taxation of labour income and the empirical work on labour supply and the elasticity of taxable income in Sweden. It also presents an overview of Swedish taxation of labour income, offers calculations on the development in effective marginal tax rates and participation tax rates, and estimates, using the difference-in-differences method, the impact of tax incentives on employment rates of elderly workers. After this background, we ponder possibilities for reforming the Swedish tax system to improve its labour market impacts. We suggest better targeting the earned income tax credit at families and low-income workers, lowering the top marginal tax rates, and maintaining the tax incentives for older workers.

Closing the 49th Parallel: An Unexplored Episode in Canadian Economic and Political History

We draw attention to, and begin to consider the implications of, the severe restrictions on emigration by Canadians to the United States introduced under the US Immigration Act of 1965. These restrictions came into effect in 1968 and lasted until mobility began to increase to some extent under the free trade agreements in the early 1990s. This is an unusual episode in Canadian history, the implications of which for the Canadian economy and for Canadian public policy appear to have received little attention. We assemble evidence that suggests that the near closing of the border led toward uncoupling of Canadian and US labour markets and to a decrease in the elasticity of labour supply in Canada. Implications for Canadian fiscal policy of a decline in labour elasticity are then derived using a model of equilibrium fiscal structure. We show that these predictions, including heavier taxation of labour income and an increase in the overall size of the public sector, are consistent with what occurred over the two decades after the near closing of the US border, as well as with the partial reopening following the free trade agreements. The analysis continues by acknowledging additional factors that determine the structure and size of the public sector, and by considering the near closing of the border in a broader historical context. We conclude with a prediction about the future course of Canada-US migration policy that follows from our analysis.

Education and Optimal Dynamic Taxation

We study optimal tax and educational policies in a dynamic private information economy, in which ex-ante heterogeneous individuals make an educational investment early in their life and face a stochastic wage distribution. We characterize labor and education wedges in this setting analytically and numerically, using a calibrated example. We present ways to implement the optimum. In one implementation there is a common labor income tax schedule, and a repayment schedule for government loans given out to agents during education. These repayment plans are contingent on loan size and income and capture the history dependence of the labor wedges. Applying the model to US-data and a binary education decision (graduating from college or not) we characterize optimal labor wedges for individuals without college degree and with college degree. The labor wedge of college graduates as a function of income lies first strictly above their counterparts from high-school, but this reverses at higher incomes. The loan repayment schedule is hump-shaped in income for college graduates.

Income Tax or Employer's Contribution an Experiment on the Perception of 'Economically Equivalent' Duties

Under full rationality a labor income tax and a corresponding employer’s contribution are equivalent. Without full rationality this equivalence is no longer obvious. If people react differently to these duties this has direct impact on policy making and also has consequences for optimal taxation theory and political economics. This paper examines how people react to these duties in a laboratory experiment. This is primarily done with respect to labor supply decisions and with respect to the value individuals attribute to working under distinct tax regimes. We find that these duties are not equivalent. The differences between the regimes are especially pronounced with respect to the value attributed to having a job. Subjects are will- ing to bear higher costs to be able to work facing an income tax than facing an employer’s contribution even when the two are economically equivalent.

Public Capital and Imperfect Competition with Endogenous Growth

This paper sets up an endogenous growth model in which public capital is a productive input and where the intermediate goods sector is characterized by monopolistic competition. The model is used to examine the effects of monopoly power, and the taxation policy on the economic growth rate. Three major findings emerge from our analysis. First, an increase in monopoly power may enhance economic growth. Second, the capital income tax policy has an ambiguous effect on the economic growth rate. Third, a higher labor income tax rate will always increase the economic growth rate.

POSITIONAL CONCERNS IN AN OLG MODEL: OPTIMAL LABOR AND CAPITAL INCOME TAXATION*

This article concerns optimal income taxation under asymmetric information in a two‐type OLG model when individuals’ relative consumption matters. Positional concerns affect the policy choices via two channels: (i) the average degree of positionality and (ii) positionality differences between the low‐ability type and the mimicker. Under plausible empirical estimates, the marginal labor income tax rates become substantially larger, and the absolute value of the marginal capital income tax rate of the low‐ability type becomes substantially smaller, than in the conventional model. In addition to measures of reference consumption based on average consumption, we also address within‐generation and upward comparisons.

Optimal tax rules and public sector efficiency with an externality in an overlapping generations model

This paper examines optimal tax rules and public sector efficiency, integrating them in a second-best world with pollution by using an overlapping generations model. The second-best world is characterized by the comparative statics of green preferences. The main results obtained are as follows. First, the marginal cost of public funds may be reduced by the externalities, regardless of the choice of taxes. Second, optimal environmental and non-environmental tax rules are additively and directly affected by the dynamic efficiency of capital accumulation per unit labour (DECAL), and indirectly by it, through the efficiency of the public sector. Environmental taxes going beyond Pigovian ones may be welfare-improving if the DECAL is improved by the environmental tax. Even optimal non-environmental tax rules should additively and directly counter the dynamics of pollution to consider the income effects of the optimal tax system for the future. Third, the “additivity property,” or the “principle of targeting,” does not hold even in the absence of incentive compatibility constraints. The essential reasons for this are clarified as follows: distortions that should be countered by taxes; that is, the income effects of the optimal tax system and the DECAL in this model, break the equality between optimal environmental taxes and the externalities measured by governments. Finally, growing environmental concerns may, in fact, increase pollution. The inverse relationship between environmental and labour income taxes may not hold.