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Empirical Optimal Income Taxation: A Microeconometric Application to Norway
01 Sep 2011-Research Papers in Economics (CHILD - Centre for Household, Income, Labour and Demographic economics - ITALY)-
TL;DR: In this article, the authors present an approach based on a computational approach to the optimal taxation problem, where they identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue.
Abstract: The purpose of this paper is to present an exercise where we identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue. Empirical applications of optimal taxation theory have typically adopted analytical expressions for the optimal taxes and then imputed numerical values to their parameters by using “calibration” procedures or previous econometric estimates. Besides the restrictiveness of the assumptions needed to obtain analytical solutions to the optimal taxation problem, a shortcoming of that procedure is the possible inconsistency between the theoretical assumptions and the assumptions implicit in the empirical evidence. In this paper we follow a different procedure, based on a computational approach to the optimal taxation problem. To this end, we estimate a microeconomic model with 78 parameters that capture heterogeneity in consumption-leisure preferences for singles and couples as well as in job opportunities across individuals based on detailed Norwegian household data for 1994. For any given tax rule, the estimated model can be used to simulate the labour supply choices made by single individuals and couples. Those choices are therefore generated by preferences and opportunities that vary across the decision units. We then identify optimal tax rules – within a class of 9-parameter piece-wise linear rules - by iteratively running the model until a given social welfare function attains its maximum under the constraint of keeping constant the total net tax revenue. The parameters to be determined are an exemption level, four marginal tax rates, three “kink points” and a lump sum transfer that can be positive (benefit) or negative (tax). We explore a variety of social welfare functions with differing degree of inequality aversion. All the social welfare functions imply monotonically increasing marginal tax rates. When compared with the current (1994) tax systems, the optimal rules imply a lower average tax rate. Moreover, all the optimal rules imply – with respect to the current rule – lower marginal rates on low and/or average income levels and higher marginal rates on relatively high income levels. These results are partially at odds with the tax reforms that took place in many countries during the last decades. While those reforms embodied the idea of lowering average tax rates, the way to implement it has typically consisted in reducing the top marginal rates. Our results instead suggest to lower average tax rates by reducing marginal rates on low and average income levels and increasing marginal rates on very high income levels.
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Posted Content•
TL;DR: In this article, the authors present an approach based on a computational approach to the optimal taxation problem, where they identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue.
Abstract: The purpose of this paper is to present an exercise where we identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue. Empirical applications of optimal taxation theory have typically adopted analytical expressions for the optimal taxes and then imputed numerical values to their parameters by using “calibration” procedures or previous econometric estimates. Besides the restrictiveness of the assumptions needed to obtain analytical solutions to the optimal taxation problem, a shortcoming of that procedure is the possible inconsistency between the theoretical assumptions and the assumptions implicit in the empirical evidence. In this paper we follow a different procedure, based on a computational approach to the optimal taxation problem. To this end, we estimate a microeconomic model with 78 parameters that capture heterogeneity in consumption-leisure preferences for singles and couples as well as in job opportunities across individuals based on detailed Norwegian household data for 1994. For any given tax rule, the estimated model can be used to simulate the labour supply choices made by single individuals and couples. Those choices are therefore generated by preferences and opportunities that vary across the decision units. We then identify optimal tax rules – within a class of 9-parameter piece-wise linear rules - by iteratively running the model until a given social welfare function attains its maximum under the constraint of keeping constant the total net tax revenue. The parameters to be determined are an exemption level, four marginal tax rates, three “kink points” and a lump sum transfer that can be positive (benefit) or negative (tax). We explore a variety of social welfare functions with differing degree of inequality aversion. All the social welfare functions imply monotonically increasing marginal tax rates. When compared with the current (1994) tax systems, the optimal rules imply a lower average tax rate. Moreover, all the optimal rules imply – with respect to the current rule – lower marginal rates on low and/or average income levels and higher marginal rates on relatively high income levels. These results are partially at odds with the tax reforms that took place in many countries during the last decades. While those reforms embodied the idea of lowering average tax rates, the way to implement it has typically consisted in reducing the top marginal rates. Our results instead suggest to lower average tax rates by reducing marginal rates on low and average income levels and increasing marginal rates on very high income levels.
50 citations
Cites background or methods from "Empirical Optimal Income Taxation: ..."
...The estimates are reported in Aaberge and Colombino (2011)....
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...…systems that can then be more deeply investigated with the microeconometric model.22 The microeconometric model adopted in this paper, and fully described by Aaberge and Colombino (2006, 2011), is designed to allow for a detailed description of complex choice sets and budget constraints....
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...The empirical specification of the model and the estimates of the model parameters have already been provided by Aaberge and Colombino (2011)....
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...The Box−Cox functional form of expression (4) is the same as that adopted for specifying the utility functions in the microeconometric model (Aaberge and Colombino, 2006, 2011)....
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...The extension to couples has been fully explained by Aaberge and Colombino (2011)....
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TL;DR: In this article, a peer-reviewed version of the article is published in final form at https://doi.org/10.1111/sjoe.12015 This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.
Abstract: "This is the peer reviewed version of the article, which has been published in final form at https://doi.org/10.1111/sjoe.12015 This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions."
43 citations
TL;DR: In this article, preference heterogeneity within and across countries and analyze several welfare criteria which take into account that differences in income are partly due to differences in tastes, rather than demographic composition.
Abstract: Following the report of the Stiglitz Commission, measuring and comparing well-being across countries has gained renewed interest. Yet, analyses that go beyond income and incorporate non-market dimensions of welfare most often rely on the assumption of identical preferences to avoid the difficulties related to interpersonal comparisons. In this paper, we suggest an international comparison based on individual welfare rankings that fully retain preference heterogeneity. Focusing on the consumption-leisure trade-off, we estimate discrete choice labor supply models using harmonized microdata for 11 European countries and the US. We retrieve preference heterogeneity within and across countries and analyze several welfare criteria which take into account that differences in income are partly due to differences in tastes. The resulting welfare rankings clearly depend on the normative treatment of preference heterogeneity with alternative metrics. We show that these differences can indeed be explained by estimated preference heterogeneity across countries—rather than demographic composition.
39 citations
TL;DR: In this paper, the authors apply individual welfare measures in the context of preference heterogeneity, derived from structural labour supply models, to preserve preference heterogeneity in the normative step of the analysis.
Abstract: We apply recently proposed individual welfare measures in the context of preference heterogeneity, derived from structural labour supply models. Contrary to the standard practice of using reference preferences and wages, these measures preserve preference heterogeneity in the normative step of the analysis. They also make the ethical priors, implicit in any interpersonal comparison, more explicit. Information on preference heterogeneity is obtained from a structural discrete choice labour supply model for married women estimated on microdata from the Socio Economic Panel in Germany. We construct welfare orderings of households according to the different metrics, each embodying different ethical choices concerning the treatment of preference heterogeneity in the consumption-leisure space and provide empirical evidence about the sensitivity of the welfare orderings to different normative principles. We also discuss how sensitive the assessment of a tax reform is to the choice of different metrics.
37 citations
Cites background or methods from "Empirical Optimal Income Taxation: ..."
...( ) = argmax [( ; z) | ≤ ( ; z) ≤ 1] (1)...
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...The discrete choice model starts from an empirical counterpart of the utility function in (1), by specifying the utility level of household at a finite number of discrete chosen levels of labour supply....
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...Recent applications of this approach in the context of labour supply concern e.g. Aaberge et al. (2004) and Aaberge and Colombino (2011)....
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...7For applications in the context of labour supply and tax reform, see Aaberge, Colombino and Strøm (2004) and Aaberge and Colombino (2011)....
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TL;DR: In this paper, the effects and the social welfare performance of 15 reforms resulting from three versions of five basic types of universal income support mechanisms: Guaranteed Minimum Income (GMI), Unconditional Basic Income (UBI), Wage Subsidy (WS), and two mixed systems: GMI+WS and UBI+WS.
Abstract: Differently from most European countries and despite the recommendations on the part of the European Commission, Italy still misses a sufficiently systematic and nationwide mechanism of income support. In this paper we explore the feasibility, the desirability and the features of a universal policy of minimum income in Italy. We use a microeconometric model and a social welfare methodology in order to evaluate various alternatives mechanisms. We simulate the effects and the social welfare performance of 15 reforms resulting from three versions of five basic types of universal income support mechanism: Guaranteed Minimum Income (GMI), Unconditional Basic Income (UBI), Wage Subsidy (WS) and two mixed systems: GMI+WS and UBI+WS. As a welfare evaluation criterion we adopt the Gini Social Welfare function. The simulation exercise has two distinctive features that are not common in the tax-reforms literature: first, all the reforms are calibrated so as to preserve fiscal neutrality; second, we adopt a method that allows for market equilibrium and ensures a consistent comparative statics interpretation of the results. In the most scenarios, the social-welfare-optimal policies are an unconditional transfer combined with a wage subsidy (a total benefit amounting to about 75% of the poverty level). In this exercise the reforms can be financed by proportionally increasing the current marginal tax rates and widening the tax base to include all personal incomes, with top marginal rates close to the ones currently applied in some Scandinavian countries. The set of universalistic policies that are preferable to the current system is however very large and appears to give the opportunity of selecting a best reform according to many different criteria or constraints.
18 citations
Cites background or methods from "Empirical Optimal Income Taxation: ..."
...3 A similar approach is adopted by Aaberge and Colombino (2011, 2012) and by Blundell and Shephard (2012)....
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...10 See Aaberge (2007) and Aaberge and Colombino (2011, 2012)....
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References
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Book•
01 Jan 1980
TL;DR: Deaton and Muellbauer as mentioned in this paper introduced generations of students to the economic theory of consumer behaviour and used it in applied econometrics, including consumer index numbers, household characteristics, demand, and household welfare comparisons.
Abstract: This classic text has introduced generations of students to the economic theory of consumer behaviour. Written by 2015 Nobel Laureate Angus Deaton and John Muellbauer, the book begins with a self-contained presentation of the basic theory and its use in applied econometrics. These early chapters also include elementary extensions of the theory to labour supply, durable goods, the consumption function, and rationing. The rest of the book is divided into three parts. In the first of these the authors discuss restrictions on choice and aggregation problems. The next part consists of chapters on consumer index numbers; household characteristics, demand, and household welfare comparisons; and social welfare and inequality. The last part extends the coverage of consumer behaviour to include the quality of goods and household production theory, labour supply and human capital theory, the consumption function and intertemporal choice, the demand for durable goods, and choice under uncertainty.
3,952 citations
Journal Article•
TL;DR: The problem of translating the theory of economic choice behavior into concrete models suitable for analyzing housing location and methods for controlling the size of data collection and estimation tasks by sampling alternatives from the full set of alternatives are discussed.
Abstract: The problem of translating the theory of economic choice behavior into concrete models suitable for analyzing housing location is discussed. The analysis is based on the premise that the classical, economically rational consumer will choose a residential location by weighing the attributes of each available alternative and by selecting the alternative that maximizes utility. The assumption of independence in the commonly used multinomial logit model of choice is relaxed to permit a structure of perceived similarities among alternatives. In this analysis, choice is described by a multinomial logit model for aggregates of similar alternatives. Also discussed are methods for controlling the size of data collection and estimation tasks by sampling alternatives from the full set of alternatives. /Author/
3,138 citations
TL;DR: In this article, a new theory of choice under risk is proposed, a theory which, in a sense that will become clear, is dual to expected utility theory, hence the title "dual theory."
Abstract: IN THIS ESSAY, a new theory of choice under risk is being proposed. It is a theory which, in a sense that will become clear, is dual to expected utility theory, hence the title "dual theory." Risky prospects are evaluated in this theory by a cardinal numerical scale which resembles an expected utility, except that the roles of payments and probabilities are reversed. This theme-the reversal of the roles of probabilities and payments-will recur throughout the paper. I should emphasize that playing games, with probabilities masquerading as payments and payments masquerading as probabilities, is not my object. Rather, I hope to convince the reader that the dual theory has intrinsic economic significance and that, in some areas, its predictions are superior to those of expected utility theory (while in other areas the reverse will be the case). Two reasons have prompted me to look for an alternative to expected utility theory. The first reason is methodological: In expected utility theory, the agent's attitude towards risk and the agent's attitude towards wealth are forever bonded together. At the level of fundamental principles, risk aversion and diminishing marginal utility of wealth, which are synonymous under expected utility theory, are horses of different colors. The former expresses an attitute towards risk (increased uncertainty hurts) while the latter expresses an attitude towards wealth (the loss of a sheep hurts more when the agent is poor than when the agent is rich). A question arises, therefore, as to whether these two notions can be kept separate from each other in a full-fledged theory of cardinal utility. The dual theory will have this property. The second reason that leads me to look for an alternative to expected utility theory is empirical: Behavior patterns which are systematic, yet inconsistent with expected utility theory, have often been observed. (Two prominent references, among many others, are Allais (1953) and Kahneman-Tversky (1979).) So deeply
2,382 citations
TL;DR: The authors found that the overall elasticity of taxable income is approximately 0.4 and that the elasticity is primarily due to a very elastic response of tax income for taxpayers who have incomes above $100,000 per year, who have an elasticity between 0.57 and 1.3.
794 citations
Posted Content•
TL;DR: In this article, the authors investigated the optimal income transfer problem at the low end of the income distribution and derived optimal tax formulas as a function of the behavioral elasticities, the shape of income distribution, and the redistribution tastes of the government.
Abstract: This paper investigates the optimal income transfer problem at the low end of the income distribution. The government maximizes a social welfare function and faces the traditional equity-efficiency trade-off. The paper models labor supply behavioral responses along the intensive margin (hours or intensity of work on the job) and along the extensive margin (participation in the labor force). Optimal tax formulas are derived as a function of the behavioral elasticities, the shape of the income distribution and the redistribution tastes of the government. When behavioral responses are concentrated along the intensive margin, the optimal transfer program is a classical Negative Income Tax program with a substantial guaranteed income support that is taxed away at high rates. However, when behavioral responses are concentrated along the extensive margin, the optimal transfer program is an Earned Income Credit program with negative marginal tax rates at low income levels and a small guaranteed income. Numerical simulations calibrated with the actual empirical earnings distribution are presented for a range of behavioral elasticities and redistributive tastes of the government. For realistic elasticities, the optimal program provides a moderate guaranteed income, imposes low tax rates on very low annual earnings levels, and then starts phasing out benefits at substantial rates.
659 citations