THE CREDIT‐CHANNEL TRANSMISSION MECHANISM AND THE NONLINEAR GROWTH AND WELFARE EFFECTS OF INFLATION AND TAXES

With the credit‐channel effect driven by the central bank's open market operations, this paper's model easily gives rise to the nonlinear inflation‐growth nexus, which is evidenced by a number of cross‐country empirical studies. The threshold level of the inflation rate is found to be lower when tax rates are higher. The presence of the credit‐channel effect also provides the rationale for setting positive (and smaller than 1) tax rates on consumption, labor income, and capital income. The optimal tax rates rise as the inflation target declines. Under a fiscal policy rule where labor and capital income taxes move proportionally to each other, the optimal capital income tax rate could be higher than the optimal labor income tax rate. Under a sufficiently large central bank balance sheet, the credit‐channel effect will be so weak that inflation and all kinds of taxes are growth and welfare repressing. This provides a rationale for central banks that have implemented quantitative easing policies to shrink their balance sheets. (JEL E58, E62, O42)     

The Welfare Effects of the Reagan Deficits: A Portfolio Choice Approach

I analyze the incidence of U.S. fiscal policy using a two-period, general equilibrium portfolio choice model with imperfect capital markets. Using data from the 1983–89 Panel Survey of Consumer Finances, I divide the population into three groups according to their 1982 portfolio choices and calculate average tax rates for each class of asset holders. Compared to the counterfactual of constant tax rates, the high deficits of the 1980 s harmed the welfare of two large minorities concentrated in both the higher- and lower-income groups, but benefited the majority whose income fell largely in the middle of the income distribution.     

THE WELFARE COSTS OF DEFICIT FINANCE

We analyze the welfare consequences of deficit finance in a general equilibrium model fit to the US. economy. Current spending may be financed with current and/or future distortionary taxes. The economy is open to international capital flows. The welfare costs of financing marginal current spending are substantial and are sensitive to the timing of the required taxes; postponing a tax on labor income is advantageous but postponing a tax on asset income is not. Ricardian equivalence poorly approximates the economy we consider.     

International Tax Competition: A Case for International Cooperation in Globalization

The liberalization of international financial flows and foreign direct investment has induced countries to use diverse measures to attract inflow of foreign capital and foreign direct investment, which is expected to have a positive effect on the growth of GDP and thus a positive effect on social welfare. Tax exemption, reduction of tax rate, tax holiday, or diverse subsidies are some of the most important measures used. In this paper we study international tax cooperation, i.e., countries change and especially reduce tax rate for corporate income or for asset revenues to attract inflow of foreign direct investment. Both theoretical and empirical studies have shown the sensibility of foreign direct investment decision with respect to tax rate differences between home countries and host countries. In general, more inflow of foreign direct investment can be expected if the tax rate of the home country is lower than that of foreign countries. This is the main reason for international tax cooperation. In this paper we propose a simple model to prove the sub-optimal Nash non cooperative solution in a two-country tax-competition game. The model shows that international tax cooperation can improve welfare of the participating countries. How to reach a cooperative solution for an international tax competition game (ITCG) is therefore an important issue for further discussions and studies. International institutions can play a crucial role to reach international tax cooperation or international tax harmonization.     

REDISTRIBUTING INCOMES: EX ANTE OR EX POST

The standard analyses of optimal income taxation assume that the distribution of gross wages in the economy is immutable depending as it does on the distribution of innate abilities. In this paper I assume that wage distribution is not fixed but that it can be varied, up to a point, by more or less precise measurement of workers' innate abilities. I demonstrate that complete knowledge of abilities is not desirable if income can only be distributed using a linear tax. I isolate those variables which favor the narrowing of wage inequality measured by the variance with the mean held constant. This section of the paper is related to the existing literature on the desirability of price randomization.
In the second part of the paper I consider the consequences of spreading wage distributions on the optimal tax rate. It is shown that those consequences are ambiguous and dependent on the form of the social welfare function.     

The effects of economic instability on children's educational outcomes

Welfare Based on Assets, a Way to Smooth Out Economic Instability and Develop Children's Human Capital is a four-part series of papers that focuses on the relationship between economic instability (i.e., income shocks, asset shocks, home loss, and asset poverty) and children's human capital development. Collectively, these reports build on the compelling observation that the pattern low-income families walk into is a present time oriented or consumption based pattern of behavior; in contrast, the pattern higher income families walk into is future oriented or asset based. In the third paper we find in most cases income shocks and asset shocks do not appear to be harmful to children's educational outcomes. However, children living in liquid and net worth asset poor families have lower academic achievement scores, high school graduation rates, college enrollment rates, and college graduation rates than children living in families that are asset sufficient. Overall, findings can be interpreted as suggesting that a bifurcated welfare system, with income-based programs for poor families and asset-based programs for higher income families, may provide higher income families with an educational advantage over low-income families and might ultimately help exacerbate educational inequalities in America.     

Distribution-neutral provision of public goods

The paper describes a normative approach to budget incidence, given the provision of a public good. The objective is to balance the budget by an income tax such that the budget is distribution-neutral. This property requires that every consumer’s net welfare gain, i.e. the benefit from consuming the public good and the tax burden in financing it, does not change the inequality inherent in the income distribution. The properties of the distribution-neutral tax are investigated and completely determined. The marginal willingness to pay for the public good is decisive for the degree of progression of the tax schedule. My co-author Georg Tillmann passed away in March 2006, much too soon. He was my friend, more than a colleague. I dedicate this paper to his memory.     

Human development and the optimal size of government

Previous studies have found evidence for an optimal size of government with respect to GDP growth. In this paper, I look at the impact of the size of government consumption expenditures on social welfare as measured by the Human Development Index. Utilizing dynamic GMM estimation in a panel data framework, I find that evidence for an optimal size of government with respect to social welfare.     

Tax–benefit revealed social preferences

This paper inverts the usual logic of applied optimal income taxation. It starts from the observed distribution of income before and after redistribution and corresponding marginal tax rates. Under a set of simplifying assumptions, it is then possible to recover the social welfare function that would make the observed marginal tax rate schedule optimal. In this framework, the issue of the optimality of an existing tax–benefit system is transformed into the issue of the shape of the social welfare function associated with that system and whether it satisfies elementary properties. This method is applied to the French redistribution system with the interesting implication that the French redistribution authority may appear, under some plausible scenario concerning the size of the labor supply behavioral reactions, non Paretian (e.g. giving negative marginal social weights to the richest class of tax payers).     

Growth with Endogenous Risk of Biological Invasion

We model biological invasions as an unintended by-product of capital accumulation. We distinguish three spillover effects: (1) a negative production externality, (2) a negative or positive consumption externality and (3) an increase in the risk of future welfare loss. We also consider the implications when households self-protect by allocating income to reduce the potential damages from a biological invasion. An optimal output tax for production externalities is straightforward and can be augmented in the case of negative or positive spillover effects on consumer welfare. Policies to correct the effect of invasions on endogenous risk are more difficult to design.     

International Profit‐Shifting out of Developing Countries and the Role of Tax Havens

This article contributes to the debate on how tax avoidance and evasion can hamper development efforts by investigating the link between profit‐shifting out of developing countries and tax havens. Analysis of more than 1500 multinational corporations (MNCs) operating in India shows that in 2010 those MNCs with links to tax havens reported lower profits and paid less in taxes per unit of asset than MNCs with no such links. This confirms the notion that when corporations have links to tax havens they enjoy higher incentives, because of the low tax rates, and opportunities to shift income because of the secrecy provisions tax havens offer.     

Shall we keep the highly skilled at home? The optimal income tax perspective

We examine how allowing individuals to emigrate to pay lower taxes abroad changes the optimal non-linear income tax scheme in a Mirrleesian economy. An individual emigrates if his domestic utility is less than his utility abroad net of migration costs, utilities and costs both depending on productivity. Three average social criteria are distinguished—national, citizen and resident—according to the agents whose welfare matters. A curse of the middle-skilled occurs in the first-best, and it may be optimal to let some highly skilled leave the country under the resident criterion. In the second-best, under the Citizen and Resident criteria, preventing emigration of the highly skilled is not necessarily optimal because the interaction between the incentive-compatibility and participations constraints may cause countervailing incentives. In important cases, a Rawlsian policymaker should decrease top marginal tax rates to keep everyone at home.     

Probability of living through a period of economic instability

Welfare Based on Assets, a Way to Smooth Out Economic Instability and Develop Children's Human Capital is a four-part series of reports that focuses on the relationship between economic instability (i.e., income shocks, asset shocks, home loss, and asset poverty) and children's human capital development. Collectively, these reports build on the compelling observation that the pattern low-income families walk into is a present time oriented or consumption based pattern of behavior; in contrast, the pattern higher income families walk into is future oriented or asset based. In this first paper we find that between 2005 and 2009 the probability of a low-income child living through an income shock is between 43% (major shock) and 55% (minor shock). In contrast, the chance of a high-income child experiencing an income shock is between 6% (major shock) and 15% (minor shock) during the same period. We also find that the probability that a child will experience a net worth asset shock close to doubles for a child living in a black or low-income family between 2005 and 2009 when compared to 2000 and 2004. Policy implications are discussed.     

Optimal nonlinear income tax and nonlinear pricing: optimality conditions and comparative static properties

Using the Mirrlees optimal income tax model, with no income effects on labour supply, this article shows that the discrete population approach provides new insights into the characterization of the optimal tax system, which complements the previous findings. The analysis is based on the “Spence-Mirrlees wedge” which corresponds, at each observed gross income level, to a ratio between the marginal tax rate of the individual for whom the bundle is designed and that of his nearest more productive neighbour if he chooses to mimic. Using this wedge, a necessary and sufficient condition for bunching to be optimal is obtained in terms of the primitives of the model, separating optima are characterized geometrically, and comparative statics properties derived, notably with respect to skill levels and individual social weights. It is then shown that the analysis extends to adverse-selection problems where participation constraints replace the tax revenue constraint.     

THE DETERMINANTS OF THE PUBLIC DEBT IN THE UNITED STATES, 1953–1978

Barro claims that since the public rationally forecasts and discounts future taxes, government debt does not represent net wealth to the public and therefore does not affect any real economic variables. Then why are there ever deficits? Barro has presented a theory of optimal deficits based on intertemporal tax smoothing. The theory predicts that nominal debt grows in proportion to anticipated inflation, varies contracyclically with respect to real income cycles, and varies procyclically with respect to war cycles. Barro tested his theory using annual American data for 1922-76 and found weak support for his theory. This paper reexamines Barro's tests, using quarterly American data for 1953:Q1 to 1978:Q4 and finds stronger support for Barro's theory than Barro found using annual data. This paper also concludes that state and local governments do not engage in tax-smoothing behavior–––probably due to considerations of migration–––and that the debt held by the central bank should be included in the definition of public debt.     

Veblen’s theory of the leisure class revisited: implications for optimal income taxation

Several previous studies have demonstrated the importance of relative consumption comparisons for public policy. Yet, almost all of them have ignored the role of leisure for status comparisons. Inspired by Veblen (The theory of the leisure class. Macmillan, New York, 1899), this paper assumes that people care about their relative consumption and that leisure has a displaying role in making relative consumption more visible, based on a two-type model of optimal income taxation. While increased importance of relative consumption typically implies higher marginal income tax rates, in line with previous research, the effect of leisure-induced consumption visibility is to make the income tax more regressive in terms of ability.     

TAX-RATE UNCERTAINTY, FACTOR SUPPLIES, AND WELFARE

Uncertainty about prospective changes in tax rates may increase factor supplies, and hence the tax base, permitting a reduction in tax rates that could result in a net increase in welfare. Under empirically relevant assumptions about attitudes towards risk we find that when an individual exclusively saves or works, the tax base rises in response to greater tax-rate uncertainty, so that welfare could indeed increase. However, when an individual both saves and works, the supply of the randomly taxed factor declines with increased uncertainty, implying that tax revenue and welfare decrease when the nonrandom tax rate is sufficiently low.     

HOW DOES GLOBALIZATION AFFECT THE IMPLICIT TAX RATES ON LABOR INCOME,CAPITAL INCOME,AND CONSUMPTION IN THE EUROPEAN UNION?

This article analyzes the effects of globalization on implicit tax rates (ITRs) on labor income, capital income, and consumption in the EU15 and Central and Eastern European New Member States (CEE NMS). We find supportive evidence for an increase in the ITR on labor income in the EU15, but no effect on the ITR on capital income. There is evidence of convergence in terms of the ITR on consumption, as countries with higher than average ITR on consumption respond to globalization by decreasing their tax rates. There are important differences among the welfare regimes within the EU15. Social‐democratic countries have decreased the tax burden on capital, but increased that on labor due to globalization. Globalization exerts a pressure to increase taxes on labor income in the conservative and liberal regimes as well. Taxes on consumption decrease in response to globalization in the conservative and social‐democratic regimes. In the CEE NMS, there is no effect of globalization on the ITR on labor and capital income, but we find a negative impact on the ITR on consumption in the CEE NMS with higher than average ITR on consumption. (JEL H23, H24, H25, F19, F21)     

The political viability of a negative income tax

This paper offers three propositions relating to the political viability of the negative income tax. One, despite its work disincentive, a majority of households would support a linear income tax that makes cash payments to low income households. However two, when government consumption is sufficiently high, a majority would favor a proportional tax over such a tax. Three, under certain conditions, a majority of households will prefer public provision of a private good or an in-kind transfer to a negative income tax. These latter two propositions offer an explanation for the public's apparent distaste for widespread cash transfers. Received: 17 September 1999/Accepted: 21 April 2000     

Impacts of Long-Range Increases in the Fuel Economy (CAFE) Standard

This work models the impact of higher CAFE standards on producer and consumer welfare, gasoline consumption, externalities from increased driving, and the emissions of traditional pollutants. In particular, a long-run 3.0 MPG increase in the CAFE standard is estimated to impose welfare losses of about $4 billion per year and save about 5.2 billion gallons of gasoline per year, for a hidden tax of $0.78 per gallon conserved. An 11-cent-per-gallon increase in the gasoline tax would save the same amount of fuel at a welfare cost of about $290 million per year, or about one-fourteenth the cost. (JEL L51 , Q30 )