Economics of Tax Policy
Tax morale is typically linked to ...
- Democracy - churches -Education ( a little) - Trust in legal system
Arguments AGAINST Inheritance tax
-Equally well-off individuals are taxed differently based on how much they spent in their lifetime. This isn't fair because you are taxed based on your consumption decisions (commodity tax?) - The wealthy get out of this tax. They "gift" things to their kids long before they die because they can afford to and its untaxed. Meanwhile, middle class families cant gift things becaues they are still using them, therefore all of their inheritance gets taxed. -Inheritance tax can be seen as double taxation. this money was already taxed for income so its unfair to tax it again. However, some of this money may come from capital gains (i.e. increase in home value) and this money has not been taxed.
Introducing a tax on your first $10,000 earned would cause _____ if you work under it and ______ if you work above it
1. An income and substitution effect. 2. Only an income effect because the new tax doesn't effect your MARGINAL tax rate, so no substitution effect
Increasing probability of catching tax evaders vs increasing the fine and things not accounted for in the "criminal" model
1. Other costs of evading taxes. Social pressures might make you want to evade or pay. Firms might look bad if they are evading taxes 2. Mistakes made filing taxes. If you are caught and you made a mistake and increased the fine, then you are screwed! 3. Different government offices might treat penalties for tax evasion differently 4. Costs much less to increase fine then to increase probability 5. Politically, people do not like more tax officials
Individual's choices to Save/ Borrow
1. Overall, we cannot consume more than we make
Ways to use "tax avoidance"
1. Retiming the payement of taxes if you know a tax policy change will occur 2. Borrowing and/or buying in a way which is tax-deductible 3. Classifying your income: Income and capital are taxed differently, so saying a lot of your income is put into research means less of it is taxed etc.
Arguments against an interest income tax
1. Taxing interest disincentives people to save. Some argue its "double taxation" for those who save, but thats not really the case cause invest in things then. People face different tax burdens depending on if they save or not, which might not be equal 2. Taxing interest on income saved is good for redistirubiton. This isn't actually true because more people will just consume in the first period. This is like taxing a commodity for redistribution purposes, it isn't efficent. (continuing) Think: in commodity taxing we use inverse elasticity rule. If the elasticity of future consumption is low (inelastic), then this tax would be very efficent for gov. revenue, because people would still save. 3. Taxing interest income will lead to loopholes. People will invest in assessts so they dont have to pay, and go to great lengths to do so. This is inefficent 4. If taxes are created on savings that are used in stocks, people will pull out of stocks b/c there is less return on their risk.
People will pay taxes based on 2 societal things...
1. What is everyone else doing? By not doing what they're doing, you could face serious reputational costs. 2. People tend to pay their taxes if they can see the results in public goods
Mirrlees Model Conclusions
1. You can never have a marginal tax rate over 100%. This means by increasing your hours you will have less income (Conclued in Rawlsian as well) 2. You can never have a marginal tax rate below 0%. If you do this, people could always move to a higher indifference curve at a 0% tax rate without disrupting gov. revenue. Negative MTR creates more consumption for ppl with diminishing marginal utility 3. The MTR for the highest earners must be 0%, because it improves their utility and doesn't change consumption. (Think: difference between consumption and 45 degree line). This assumes the government is using a utilitarian SWF and not a Rawlisian one
A taxpayer will engage in tax evasion if...
1/fine > probability of getting caught
Production/Commodity Externality
A 3rd party's production/utility is effected in a transaction
Pigouvian Tax/Subsidy
A tax/subsidy to cover the social cost/benefit of an externality
Extensive Margin
A worker quits or joins the labor force after a change in wage rate
Intensive Margin
A worker will change their work hours based on a change in wage rate
Substitution effect
As your income decreases, you will substitue work for leisure because leisure outways work at a certain point now
Income Effect
As your income goes down, you will work more so that you still have the same level of income.
Societal norms that pay/ don't pay taxes...
Can drive societies to extremes as teh cost get higher to go against society. Tax Evasion can go to extremes
By increasing unearned income Y...
Consumption and leisure time go up, and the work force goes down. This is only income effect, there is no change in substitution effect
Substition effect leads to this....
Deadweight loss. The higher the substitution effect the higher the DWL
Efficiency of Inheritance tax
Depends on peoples motives. If people are just earning to leave more behind, then they will work less if an inheritance tax is introduced (substitution effect). People could just use money in a way to reduce inheritance tax at all costs and that is inefficent. People might also just want to give more to their relatives, in which case an inheritance tax wouldn't effect their work. It is near impossible to distinct what motives people have.
Ways to measure tax evasion:
Direct Approaches: 1. Surveys 2 Audititing Indirect Approaches of Auditing: 1. Measuring tax gap 2. Difference in official vs actual labor force 3. Measuring the amount of transaction of money that occurs vs how much transaction should occur (Money x Turnover of money = Prices x # of transcations)
Coarse Theorem
Externalities can be fixed by creating property rights for everything
Negative Externalities of Smoking
Fires, other's health, distraction, BUT these are outweighed because smokers die younger. Therefore it seems more like a positive exeternality. Taxes seem to cover the negative effect
The Corlett-Hague Rule
Goods that are relatively more complemntary with leisure should be taxed higher. This eliminates disincentives for working because taxing time spent not working
If the government increases fines on tax evasion...
Higher fines mean a steeper budget line, and therefore indifference curves change to get lower
If the government implemented a policy where the probability of you getting caught goes up then....
Higher probabilty P ^ = amount of income declared increases X ^, and tehrefore tax evasion goes down. The indifference curves get flatter for the evaders, because the payout is less now
Income Endowment
How much an individual would spend without saving/borrowing. Consumption= income each period
Average Tax rate
How much taxes people pay based on their income
Tax Gap
How much the government should be receiving in taxes vs. how much they actually recieve
Tax Evasion
Illegal procdure in which taxpayers lie about their activites/ income so they can pay less in taxes
How would an interest income tax effect consumers?
Income effect: consumers can no longer consume as much now because savings isnt as high because of the tax. The consumer will have to save more to keep the same level of consumption. Substitution effect: The tax reduces incentives to save. Consumption increases in Period 1 and decreases in period 2, and savings will fall. Therefore, savings could increase/decrease
Commodity Tax Vs. Income Taxes
Income taxes can be imposed non-linearly- as in people can be taxed at different rates. Commodity markets are typically anonymous
Arguments FOR Inheritence Tax
Inheritance taxes reduce inequality. Inheritance is unearned by the recipient, so high taxes on inheritance are acceptable.
Tax Morale
Intrinsic motivations to pay your taxes
Justificaiton for excise duties other than externalities....
Inverse elasticity rule: Tax extremely inelastic goods, but no hard evidence that alcohol or cigs is inelastic Corleet-Hague Rule: Tax goods that are compliments of leisure, but alcohol and cigs can be used in work-induced stress Paternalism: People don't have perfect information, so by changing prices we are informing people what is good/bad. This might also apply to addictive thing such as alcohol/tobacco
Irremovable Distortions
Market is not competitive, and by levying a tax/subsidy it could effect substitues/complements
Alcohol generates negative externalities when....
People drink too much, but its hard to show a rise in negative externalities and amount of drinks on a chart because theres a lot of factors in play. Therefore the MARGINAL EXTERNALITY COST differs.
Tax avoidance disclosure (TAD)
People must disclose how they will use tax avoidance to the government
"rational addiction"
People understand that they will benefit from smoking for the next 30 years but then develop seirous health issues. They decide the benfit outweights the cost
Pros and Cons of VAT
Pros: 1. Little reason why firms would skip out on taxes because they pay less 2. Avoids taxing inputs Cons: 1. Allows for "carousel fraud" by moving taxes between EU nations w/ imports and exports 2. Widespread exmeptions are ineffecient
Extremes of the saving/borrowing curve
Saving all in the first period: Consumption in second will be: Y1(1+R) + Y2 Borrowing all in the first period: They would be allowed to borrow 1/(1+R)*Y2 and would consume it all in period 1: Y1 + 1/(1+R)*Y2
The bigger the ____ the bigger the tax gap
Shadow economy; the more transactions taht happen unknown to the government, the less paid in taxes
Laffer Curve
Showed that extremely high or tax rates cause less gov tax revenue cause people will stop working
Strong Progressivity
Tax is strongly progressive if the marginal tax rate increases with income
Weak Progressivity
Tax is weakly progressive if the average tax rate increases with income
"effective" tax rate
Tax rates that take into account worker benefits
How to tax a good with irremovable distortions?
Tax the negative externality until it has the same DWL as the monopoly complement
Marginal Tax Rate
The amount of additional tax paid for one more pound earned
Rawlsian Social Welfare Function
The entire society is only as well off as the least well off person. Therefore, high tax rates could go towards teh least well off person
Utilitarian/Mirrlees Social Welfare Function
The government cares about the average utility of its citizens.
Intertemporal budget contraint
The straight line that allows you to save/borrow in period 1, which effects your consumption in Y2
Negative externalities of Alcohol
Theres a lot, and it outweigh the tax
If income rises/ tax decreases then a tax evader would...
This creates a parallel shift of the budget line. Depends on their risk aversion. They would declare less if they have "increasing risk aversion," meaning they like risks the bigger they are.
The Inverse Elasticity Rule
This is a way of taxing certain markets. The most efficent markets to tax are: Revenue of Tax = (The Lagrange Multiplyer)/ (The own price elasticity of this good) Therefore, tax inelastic goods. This assumes no cross-price effects
Tax Avoidance
Using legal loopholes to pay less in taxes
Model for honesty in paying taxes
Utility= Utility of income - the marginical cost of evading 1 more pound TIMES amount of evasion or : U= U(Y)- XE. The higher the value of XE the more honest people are
Time-inconsistent decision
When people make a decision to use an addicitive substance and in the future decide to quit, when they reach that future point quitting is no longer the optimal decision for the consumer
Men vs. Women in changes to wage rate
Women: Higher substitution effect, will stop working all together Men: Almost no change
Taxpayers income if they choose to tax evade and get caught:
Y= W - TX - Fine *T(W-X)
Taxpayers income if they chose to tax evade and dont get caught:
Y= W- TX
An increase in the after-tax wage rate means...
uncertain results if you work more, but more consumption for sure
