Optimal Tax Policy Research Articles

Taxation of a venture capitalist with a portfolio of firms

Venture capitalists not only finance but also advise and thereby add value to young entrepreneurial firms. The prospects of venture capital backed firms thus depend on joint efforts of entrepreneurs and informed venture capitalists, and are subject to double moral hazard. For this reason, managerial support and the number of portfolio companies tend to be inefficiently low. This paper investigates how tax policy can possibly contribute to a more active style of venture capital investments. An optimal tax policy is derived that moves the private equilibrium towards a first best allocation.

Optimal Commodity Taxes with Tourist Demand

The existence of country-specific commodities that have to be bought and consumed locally plays an essential role in tourism. This paper discusses how optimal taxation rules are modified when the taxable goods include goods demanded by tourists. The main point is that tax rates can be manipulated to shift some of the tax burden from domestic residents onto tourists. There is indeed a reason why an optimum taxation approach is useful for tourism, as the goods are consumed inside the host country, and discrimination is difficult.This paper combines several scenarios where tourism may be relevant for optimal tax policy. It begins by considering the determinants of tourist demand. Then, the well-known optimal commodity tax rules are modified to include the effect of foreign demand. Tourists are assumed to trade at the same prices as domestic consumers, but to have zero welfare weight. Thus, the government must balance the desire to tax tourists with the deadweight loss suffered by its own residents. The government should raise some taxes, when tourism begins. Tourism-oriented goods with low price elasticities should bear the highest taxes. However, tourism-related pollution cannot be taxed at prohibitive rates or tourist revenue would be lost altogether. Possible extensions are introduced, for example competition among destination countries. Should tourism dependent countries that are geographical neighbours and substitutes have closely linked tax systems? What kind of tax policy is best when the tourist destinations serve as complements to each other?

Non-Welfarist Optimal Taxation and Behavioral Public Economics

Research in behavioral economics has uncovered the widespread phenomenon of people making decisions against their own good intentions. In these situations, the government might want to intervene, indeed individuals might want the government to intervene, to induce behavior that is closer to what individual wish they were doing. The analysis of such corrective interventions, through taxes and subsidies, might be called ”behavioral public economics.” However, such analysis, where the government has an objective function that is different from that of individuals, is not new in public economics. In these cases the government is said to be ”non-welfarist” in its objectives, and there is a long tradition of nonwelfarist welfare economics, especially the analysis of optimal taxation and subsidy policy where the outcomes of individual behavior are evaluated using a preference function different from the one that generated the outcomes. The object of this paper is to first of all present a unified view of the non-welfarist optimal taxation literature and, secondly, to present behavioral public economics as a natural special case of this general framework.

Some Optimal Tax Rules for International Portfolio and Direct Investment

This paper explores the optimal international tax policy of a small open economy with inbound and outbound flows of both portfolio and direct investment. Only three independent conditions determine the optimal rates of six taxes, implying that there are no unique values of optimal tax rates. For example, the optimal tax rates on domestic and inbound direct investment are related through a two sector general equilibrium model. In general, optimal tax rates on inbound investment are not zero, and those on domestic and outbound investment are not equal.

Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation

This paper studies optimal tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare-improving active, contingent tax policies (tax rates respond to changes in productivity) on consumption, and capital and labor income taxes. Unlike the conventional wisdom regarding stabilization policies, procyclical factor income tax policy is optimal in open economy. Procyclical tax policy generates efficiency gains by correcting market incompleteness. Optimal tax policy under cooperative equilibrium is similar to that under the Nash equilibrium and welfare gains from tax policy coordination is quite small.

Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation

This paper studies an international tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfareimproving active tax policies, in particular capital and labor income tax, under the non-cooperative Nash equilibrium and the cooperative equilibrium. Unlike the conventional wisdom regarding stabilization policies, optimal tax policies in our economy are procyclical. Relative to the non-cooperative setting, international tax policy cooperation requires more active tax policies (about two times) and generates large extra welfare gains (by about a third).

Conservation of a fishery through optimal taxation: a dynamic reaction model

The present paper deals with the problem of selective harvesting in a ratio-dependent predator–prey fishery in which both the predator and prey obey the logistic law of growth. To protect fish population from over exploitation a control instrument tax is imposed. The existence of its steady states and their stability are studied. The problem of optimal taxation policy is then solved by using Pontryagin's maximal principle. Finally some numerical examples are taken to illustrate the results.

Introduction: Recent Developments in Monetary Macroeconomics

IntroductionRecent Developments in Monetary Macroeconomics David Altig The contents of this volume hardly require explanation beyond its title: "Recent Developments in Monetary Macroeconomics." Our intent for the conference was to collect a set of papers reflecting the cutting edge of applied monetary macroeconomics. As befitting such an ambitious-sounding goal, the contributions are wide ranging. For purposes of this brief introduction, however, we might organize the papers as answers to three questions. (1) What is the "optimal" Taylor rule? (2) Are "New Keynesian" or "New Neoclassical Synthesis" models the final word on the monetary transmission mechanism? (3) Is there a role for money in the conduct of monetary policy? What is the "Optimal" Taylor Rule The inclusion of the Taylor rule issue is almost a prerequisite for any collection of papers purporting to survey recent developments in monetary macroeconomics. In policy discussions, the Taylor rule is ubiquitous, and it is currently the choice among alternative specifications of central bank behavior. More precisely, perhaps, the general form of the Taylor rule is the choice, as it has come to represent the general class of equations that relate the federal funds rate to some measure of an output gap and inflation rate. There is substantially less unanimity about whether output gaps and inflation rates should be past, present, or (expected) future values, whether past values of the funds rate need to be included, and what are the appropriate magnitudes of the responses to each of these measures. Marc Giannoni and Michael Woodford offer the natural approach to addressing the dispute: find the representation that is optimal within the framework being employed for policy analysis. The model in question here is essentially a derivative of the "New Neoclassical Synthesis" class of models that are currently the workhorses of most monetary policy analyses among academic and central bank staffs alike. Their approach to discovering the optimal policy within this structure has the flavor of [End Page 1039] the "Ramsey problem" familiar from optimal tax policy, although with the strong requirement that the derived policy rule be "robustly optimal": it must support the optimal equilibrium no matter what the distribution of disturbances the model policymakers face. Giannoni and Woodford offer two essential lessons. First, whether optimal policy incorporates forecasts of future price-level growth or output gaps depend critically on the dynamics of the inflation rate. If the adjustment of the price-level to shocks is inertial, then optimal policy necessarily depends on forecasts of future inflation. Second, the response of the funds rate to its own past is inertial. In fact, it is super-inertial, meaning that (all else equal), the contemporaneous funds rate responds more than one-for-one with the lagged value of the funds rate (and lagged changes in the rate). The proposition that monetary authorities ought to aggressively respond to lagged values of the funds rate also arises in the papers by Jess Benhabib, Stephanie Schmitt-Grohé, and Martín Uribe, and George Evans and Seppo Honkapohja. In the latter case, the authors consolidate and expand on their well-known work on learning dynamics. A central contribution of the work presented in this article is the notion that convergence to a unique rational expectations equilibrium under learning, as well as the stability of that equilibrium, serves as basis for the choice (or rejection) of an optimal policy formulation. An apparent lesson from Evans and Honkapohja's analysis is that the learnability criterion prescribes a policy rule that differs in some important ways from the conventional wisdom coming from analyses that invoke the Taylor rule in a pure rational expectations environment. In particular, they conclude that the optimal policy rule in the environment they consider requires the monetary authority to respond directly to private-sector expectations. The environment they consider is essentially the same as in Giannoni and Woodford, with the exception of the central bank's assumed loss function: Giannoni and Woodford assume a preference for interest rate smoothing, Evans and Honkapohja do not. In his comments, John Duffy points out that the introduction of interest-smoothing motive yields an optimal policy rule under learning that is much closer to the conventional view. In particular, it does not require...

Regulation of a prey-predator fishery by taxation

Bioeconomic exploitation of a prey-predator fishery is discussed by using a reasonable catch-rate function instead of the usual 'catch-per-unit-effort hypothesis'. The model is based on the assumption that only the prey species is harvested. A regulatory agency controls exploitation of the fishery by imposing a tax per unit biomass of the landed fish. The fishing effort is taken as a dynamic variable depending on the capital invested in the fishery. The dynamical system consisting of the growth equations of the species and also the fishing effort is formulated. The existence and stability of steady states are discussed. The optimal tax policy is studied with the help of Pontryagin's maximum principle. Finally, some numerical examples are carried out to illustrate the results of the model.

Tax Policy and Entrepreneurship in the Presence of Asymmetric Information in Capital Markets

This paper considers the implications of asymmetric information in capital markets for entrepreneurial entry and tax policy. In many countries, governments subsidize the creation of new firms. One possible justification for these subsidies is that capital markets for the financing of new firms do not function properly. We analyse this issue by assuming that entrepreneurs need outside financing for their projects and know more about the quality of their projects than outside investors. Entrepreneurs have the choice between carrying out their entrepreneurial projects or working as an employee. It turns out that asymmetric information in capital markets leads to too much rather than too little entrepreneurial entry. Therefore, the optimal tax policy should discourage rather than subsidize entrepreneurial entry. We also analyse the welfare effects of project screening and show that there is too much screening. Our policy conclusion is that subsidies for the foundation of firms must be based on reasons other than informational asymmetries in capital markets.

Optimal taxation policy maximum-entropy approach

The object of this paper is firstly to present entropic measure of income inequality and secondly to develop maximum entropy approaches for the optimal reduction of income inequality through taxation. .

Good Jobs, Bad Jobs and Redistribution

We analyse the question of optimal taxation in a dual economy, when the government is concerned about the distribution of labour income. Income inequality is caused by the presence of sunk capital investments, which creates a good jobs sector due to the capture of quasi-rents by trade unions. We find that whether the government should subsidise or tax investments is crucially dependent on union bargaining strength. If unions are weak, the optimal tax policy implies a combination of investment taxes and progressive income taxation. On the other hand, if unions are strong, we find that the best option for the government is to use investment subsidies in combination with either progressive or proportional taxation, the latter being the optimal policy if the government is not too concerned about inequality and if the cost of income taxation is sufficiently high.

Why is the corporate tax rate lower than the personal tax rate?: The role of new firms

In many OECD countries, statutory corporate tax rates are lower than personal income tax rates. This tax rate difference is often particularly large for small firms. The present paper argues that a reduction of the corporate tax rate below the personal tax rate is an optimal tax policy if there are problems of asymmetric information between investors and firms in the capital market. The reduction of the corporate tax rate below the personal tax rate encourages equity financing and thus mitigates the excessive use of debt financing induced by asymmetric information. Our main theoretical result stands in marked contrast to the traditional view of corporate taxation and corporate finance theory, according to which there is a tax disadvantage to equity financing. More recent empirical evidence on this issue, however, is in line with our result.

Taxation and Tax Policy in the E-World

Governments can regulate the economy and encourage or discourage particular forms of social behavior, by manipulating the incidence of taxation. Tax incentives in a particular area will promote expenditure: for example, tax deductions allowed to farmers will prompt them towards greater productivity. The reverse also applies: a heavy sales tax on luxury goods will reduce public demand and shift productive resources to other areas. By such means, taxation can be used to control and direct economic development. Taxation and tax policy are playing important role in the economic development in the last decades. As the principal means by which governments fund their expenditures, taxes are at the foundation of public finances. Taxes have been used throughout the world in the most of their role of regulating the economic issues. A properly designed tax system implies readier taxpayer acceptance of that expenditure burden. It should promote the maintenance of a high and sustainable level of output by minimizing both distortions to market-set prices and disincentives to work, saving and investment. But optimal tax policy goes beyond mere efficiency and funding considerations to encompass inevitable normative judgments about the amount of redistribution. The regulative role of taxation is one of the most pronounced roles from the monetarist economists. The last years we are examining a rapid development of new realities - the technological progress and e-economic development. The introduction of e-everything requires new theory and new practice for tax policy. The major goal of this paper is to outline the problems that tax policy and taxation are facing the development of the e-world. The new technologies started to ease the tax compliances and tax payments but the e-trade and other e-things at the end of the day will erode the tax base and will increase the tax avoidance and tax evasion and in that way lower the state revenues and the social welfare function.

Nonlinear Pricing, Redistribution, and Optimal Tax Policy

This paper examines the role of nonlinear pricing by public (or regulated) utilities as a redistributive mechanism in presence of an optimal nonlinear income tax. It models an economy with many types of persons who differ in two unobservable characteristics (earning abilities and tastes). We show that nonlinear pricing does have a redistributive role; it is not a substitute for an ill‐designed tax policy. We prove, assuming separable preferences, that a person whose valuation of the public sector output is smaller than the average valuation of the population (all measured at the same consumption bundle) must face a marginal price for the good above its marginal cost. Further assuming that tastes and earning abilities are perfectly correlated, we prove that everyone must face a marginal price for the public sector’s output which strictly exceeds its marginal cost if correlation is positive. These properties provide an economic rationale for the provision of “support for low‐income consumers” as mandated by the universal service and similar regulatory policies. Finally, we show that with correlated characteristics, implementation can be achieved through two separate functions: a pricing function that depends only on the public sector output and a tax function that depends only on income.

Capital income taxation when inherited wealth is not observable

This paper extends the Atkinson–Stiglitz model of direct and indirect taxation to a dynamic setting with two unobservable characteristics: productive ability and inherited wealth. Bequests are motivated by the ‘joy of giving’. A child’s inheritance is a random variable with a probability distribution that depends on his parent’s investment in a ‘bequest technology’. Public borrowing is assumed and implies the modified golden rule. We study the optimal tax policy when two instruments are available: a non-linear (wage) income tax and a proportional tax on capital income. We show that the second instrument ought, in general, to be used but that the tax rate is not necessarily positive. However, a positive tax rate is more likely when there is a positive correlation between inherited wealth and innate ability.

Optimal Tax Policies with Private-Public Clean-Up, Cross-Border Pollution and Capital Mobility

This paper builds a model of a region with two non-identical countries, cross-border pollution and free movements of goods and capital within the region. Pollution reduces welfare and there is simultaneous private and public pollution abatement. Public pollution abatement is financed with the use of lump-sum and pollution tax revenue. The introduction of public pollution abatement enables us to derive the optimal pollution taxes in terms of the marginal cost of public pollution abatement. We derive and compare for each country the Nash and cooperative lump-sum and pollution taxes and examine how cross-border pollution and capital mobility affect them. Finally, we examine the impact of capital mobility on the effectiveness of pollution taxes on net pollution.

Public spending and optimal taxes without commitment

We consider a representative agent, infinite-horizon economy where production requires private and public capital. The supply of public capital is financed through distortionary taxation. The optimal (second best) tax policy of a benevolent government is time inconsistent. We therefore introduce explicitly the constraint that at no point in time the revision of the original tax plan is desirable. We completely characterize the (third best) tax plan that satisfies this constraint, and estimate the difference in tax rate between the second and third best policy for a wide range of parameters. For some of these the difference between the second and third best tax rates is large, and so are the associated rates of economic growth.

Debt and Deficit Fluctuations and the Structure of Bond Markets

The aim of this Paper is to test for the extent of incompleteness in the market for US Government debt. We show that when a government pursues an optimal tax policy and issues a full set of contingent claims, the value of debt has the same or less persistence than other variables in the economy and declines in response to higher government expenditure shocks. Examining US data, however, reveals that debt is substantially more persistent than other variables and increases in response to adverse expenditure shocks. We show that this behaviour is best accounted for by a model of incomplete markets, where governments only issue one-period risk-free bonds. We discuss the implications of this for the optimality of debt limits, debt management and assessing the sustainability of fiscal policy.

Tax Policy and Aggregate Demand Management Under Catching Up with the Joneses

This paper examines the role for tax policies in productivity-shock driven economies with catching-up-with-the-Joneses utility functions. The optimal tax policy is shown to affect the economy countercyclically via procyclical taxes, i.e., “cooling down” the economy with higher taxes when it is “overheating” in booms and “stimulating” the economy with lower taxes in recessions to keep consumption up. Thus, models with catching-up-with-the-Joneses utility functions call for traditional Keynesian demand-management policies but for rather unorthodox reasons. (JEL E21, E62, E63)