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05/12/2010 1 pisani-ferry december 2010 1 Chapter 7 Tax policy Introduction At the core of politics and sovereignty "Taxation without representation is tyranny“ James Otis (1725-1783), US lawyer and politician at the time of the American Revolution «Pour l’entretien de la force publique, et pour les dépenses de l’administration, une contribution commune est indispensable; elle doit être également répartie entre les citoyens, en raison de leurs facultés ». Déclaration des droits de l’Homme et du Citoyen, Article 13, 1789 pisani-ferry december 2010 2
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Page 1: Chapter 7 Tax Policy - JEAN PISANI-FERRY · Corporate income tax Personal income tax Structure of taxation by tax instrument, OECD (unweighted), 1965-2007 Source: OECD The case of

05/12/2010

1

pisani-ferry december 20101

Chapter 7

Tax policy

Introduction

At the core of politics and sovereignty

"Taxation without representation is tyranny“

James Otis (1725-1783), US lawyer and politician at the time of the American

Revolution

« Pour l’entretien de la force publique, et pour les dépenses

de l’administration, une contribution commune est

indispensable; elle doit être également répartie entre les

citoyens, en raison de leurs facultés ».

Déclaration des droits de l’Homme et du Citoyen, Article 13, 1789

pisani-ferry december 2010 2

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2

pisani-ferry december 2010 3

Why taxation?

• Because governments seldom charge for their services –

hence the need for financing them through taxation

• Because taxes are instruments

– For allocative purposes – e.g. green taxes

– For distributive purposes – e.g. Income taxes

• Economic theory suggests tax policies should aim at

minimising distortions but this often conflicts with other

purposes – see Margaret Thatcher’s fall over the poll tax

• In few other fields are economics and politics as tightly

intertwined

pisani-ferry december 2010 4

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3

Outline

6.1 Issues

• What is taxation about?

• Which taxes?

• Redistribution and efficiency

6.2 Theories

• Tax incidence

• Social losses and distortions

• Optimum taxation

• Corrective taxation

• Taxation in open economies

6.3 Policies

• Efficiency

• Equity

• International coordination

pisani-ferry december 2010 5

6.1 Issues

• What is taxation about?

• Which taxes?

• Redistribution and efficiency

6.2 Theories

• Tax incidence

• Social losses and distortions

• Optimum taxation

• Corrective taxation

• Taxation in open economies

6.3 Policies

• Efficiency

• Equity

• International coordination

pisani-ferry december 2010 6

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What is taxation about?

The Musgravian trinity applies:

• Allocation

• Minimisation of distortions in the financing of public goods

• Correction of market failures

• Redistribution

• Tax policy is not the only instrument (an alternative is transfers)

but it contributes to achieving desired distribution of income and

wealth

• It is generally accepted that taxation should be either

proportional or progressive, but not regressive

• Stabilisation

• Tax policy contributes to automatic stabilisation (to an extent

that depends on income elasticities)

Some trade-offs (e.g. cigarettes)

pisani-ferry december 2010 7

How much?

pisani-ferry december 2010 8Source : OECD

15

20

25

30

35

40

45

19

65

19

67

19

69

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

% o

f G

DP

Canada

Japan

United States

EU15 unweighted

United Kingdom

Total tax revenues in selected countries, percentage of GDP, 1965-2007

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How much within the EU?

pisani-ferry december 2010 9

48.8 48.3

44.0 43.6 43.5 43.3 43.042.1 41.6

40.939.8 39.5 38.9

38.2 37.6 37.4 36.9 36.8 36.7 36.4 35.7 35.2 34.7 34.733.3 33.1

32.131.2 30.8 30.5 29.9 29.6 29.4

0

5

10

15

20

25

30

35

40

45

50

De

nm

ark

Sw

ed

en

Be

lgiu

m

No

rwa

y

Fra

nce

Ita

ly

Fin

lan

d

Au

stri

a

Cy

pru

s

Ice

lan

d

Hu

ng

ary

Ge

rma

ny

Ne

the

rla

nd

s

Slo

ve

nia

Sp

ain

EU

27

un

we

igh

ted

Cze

ch

Po

rtu

ga

l

Luxe

mb

ou

rg UK

Ne

w Z

ea

lan

d

Po

lan

d

Ma

lta

Bu

lga

ria

Ca

na

da

Est

on

ia

Gre

ece

Ire

lan

d

Au

stra

lia

Latv

ia

Lith

ua

nia

Slo

va

kia

Ro

ma

nia

% o

f G

DP

Total tax revenues in EU countries, percentage of GDP, 2007

Source: European Commission

Who collects taxes?

pisani-ferry december 2010 10

0

5

10

15

20

25

30

35

40

45

50

De

nm

ark

Sw

ed

en

Be

lgiu

m

No

rwa

y

Fra

nce

Ita

ly

Fin

lan

d

Au

stri

a

Cy

pru

s

Ice

lan

d

Hu

ng

ary

Ge

rma

ny

Ne

the

rla

nd

s

Slo

ve

nia

Sp

ain

EU

27

Cze

ch

Po

rtu

ga

l

Luxe

mb

ou

rg UK

Ne

w Z

ea

lan

d

Po

lan

d

Ma

lta

Bu

lga

ria

Ca

na

da

Est

on

ia

Gre

ece

Ire

lan

d

Au

stra

lia

Latv

ia

Lith

ua

nia

Slo

va

kia

Ro

ma

nia

Sw

itze

rla

nd

Un

ite

d S

tate

s

Ko

rea

Turk

ey

Me

xico

% o

f G

DP

Social insurance funds

Local governments

State or regional governments

Central government

Distribution of tax revenues by level of government, selected countries, 2007

Source: OECD and European Commission

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Which taxes?

Direct taxesHouseholds

- Personal income tax

- Social security contributions

- Property taxes

- Inheritance taxes

- Wealth taxes

Companies

-Corporate income tax

- Local business taxes

- Social security contributions

Indirect taxes- VAT

– Excise taxes

– Energy taxes

– Environmental taxes

Atkinson (1977) : direct taxes are those that can be personalised (adapted to the

taxpayer’s characteristics)

Only direct taxes are to be used for redistribution purposes

Obvious? If so, why do we have two VAT rates?

Genuine taxes or social security

contributions? Bismarckian vs.

Beveridgian systems

11pisani-ferry december 2010

Which taxes? Evidence

pisani-ferry december 2010 12

0

5

10

15

20

25

30

35

40

45

50

De

nm

ark

Sw

ed

en

Be

lgiu

m

Fra

nce

Ita

ly

Fin

lan

d

Au

stri

a

Cy

pru

s

Hu

ng

ary

Ge

rma

ny

Ne

the

rla

nd

s

EU

27

un

we

igh

ted

Sp

ain

Cze

ch

Po

rtu

ga

l

Luxe

mb

ou

rg UK

Po

lan

d

Ma

lta

Bu

lga

ria

Est

on

ia

Slo

ve

nia

Gre

ece

Ire

lan

d

Latv

ia

Lith

ua

nia

Slo

va

kia

Ro

ma

nia

% o

f G

DP

Social insurance

contributionsIndirect taxes

Direct taxes

Breakdown of taxation by nature of revenues, EU countries, 2007

Who is

Bismackian?

Who is

Beveridgian?

Source: European Commission

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Changes over time

pisani-ferry december 2010 13

• Rise in VAT and social security contributions

• Decline in traditional consumption taxes and (since the 1980s) income taxes

0

10

20

30

40

50

60

70

80

90

100

1965 1975 1985 1995 2007

% o

f ta

x r

ev

en

ue

s

Other taxes (incl. green taxes)

Other consumption taxes

VAT and sales tax

Property taxes

Social insurance contributions

and payroll taxes

Corporate income tax

Personal income tax

Structure of taxation by tax instrument, OECD (unweighted), 1965-2007

Source: OECD

The case of developing countries

pisani-ferry december 2010 14

Developing countries generally exhibit lower taxation (e.g. 10 to 20% of GDP

in West Africa) and they rely much more on indirect taxes, especially customs duties

y = -0,0011x + 54,379R² = 0,2979

0

10

20

30

40

50

60

70

80

90

100

0 5 000 10 000 15 000 20 000 25 000 30 000 35 000

Indirect t

axe

s (%

of pu

blic

receip

ts)

National income per capita (PPP$)

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Redistribution and efficiency

Share of first decile in national

income, USA, 1917-2007 Zooming in: decomposition

pisani-ferry december 2010 15

Source: Atkinson, Piketty and Saez (2010)

Significant differences across countries

pisani-ferry december 2010 16

Taxation plays an important role in determining disposable income inequalities

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But the structure of income changes

pisani-ferry december 2010 17

Share of national income of the .1 per cent fractile, USA, 1916-2007

Source: Atkinson, Piketty and Saez (2010)

Graphique 7.10 – Variation (en %) de la part du revenu total en faveur du premier quintile derevenu

0

0,5

1

1,5

2

2,5

3

3,5

Allemagne Belgique France Italie Irlande Royaume-Uni

Prestations Impôts

Lecture : ce graphique indique la variation de la part cumulée dans le revenu du premier quintile de la population due aux impôtsprélevés et aux prestations distribuées.

Source : d’après Bourguignon (1998).pisani-ferry december 2010 18

Some countries redistribute more in spite of

having lower taxes

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VAT is a regressive tax

pisani-ferry december 2010 19

pisani-ferry december 2010 20

Redistribution vs. efficiency:

what matters?

Marginal tax rate T’(R)

Incentives

Efficiency

Average tax rate = T(R)/R

Redistribution

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11

Marginal tax rates are often highest at the bottom of

the income distribution, resulting in poverty traps

pisani-ferry december 2010 21

Marginal net tax rate for a single-worker couple with two children in France (2010)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Multiples of minimum wage

As % of net wage

As % of gross wage

As % of supergross wage

Source: French Treasury

Evolution since the 1990s

Effective marginal income tax rate (one wage earner, family of four)

Zooming in

pisani-ferry december 2010 22

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12

Effects of the RSA allowance

pisani-ferry december 2010 23Source: French Treasury

6.1 Issues

• What is taxation about?

• Which taxes?

• Redistribution and efficiency

6.2 Theories

• Tax incidence

• Social losses and distortions

• Optimum taxation

• Corrective taxation

• Taxation in open economies

6.3 Policies

• Efficiency

• Equity

• International coordination

pisani-ferry december 2010 24

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pisani-ferry december 2010 25

Tax incidence

Q

P

PE

PE’

PE’-t

Supply

Demand

t

E

E’

Tax on supply

Q

P

PE

PE’’+t

PE’’

Supply

Demandt

E

E’’

Tax on demand

Taxation is rarely borne by the particular taxpayer who writes the check

pisani-ferry december 2010 26

Tax incidence: polar cases

Supply tax: dts > 0

• if εs = 0 (inelastic supply), the net-of-

taxes price does not change

tax is borne by the supply side

• if εs ≈ ∞ (elastic supply), the net-of-

taxes price increases: dP/P = dts/(1-ts) >0

tax is borne by the demand side

Demand tax: dtd > 0

• ifεd = 0 (inelastic demand), the net-of-taxes

price does not change, the tax is entirely

passed on to the consumer

tax is borne by the demand side

• ifεd ≈ ∞ (elastic demand), the net-of-taxes

price diminishes by dP/P = -dtd/(1+td) >0

tax is borne by the supply side

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pisani-ferry december 2010 27

Application: The effect of a cut in employers’

social security contributions

L

W

SupplyDemand

EE’

L

W

Supply

Demand

E

E’

At the level of the minimum wage At higher wage levels

If the presence of excess unskilled labour, cuts in social security contributions result

in higher employment at the level of the minimum wage

and in higher wages at higher wage levels

Tax incidence in a general equilibrium contextAn example: effect of a consumption tax on good 1

Before price adjustment After price adjustment

pisani-ferry december 2010 28

C1

P1C1+P2C2=R

0

P1(1+t)C1+P2C2=R

E

E’

C2

C1

C2

P1C1+P2C2=R

0

P’1(1+t)C1+P’2C2=R

E

E’’

A tax on the consumption of good 1 affects relative prices but also real consumer income.

This results in a change in the prices of both goods, which in turn affect real consumer income

The net effect on good 2 consumption is ambiguous

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pisani-ferry december 2010 29

Application: Who pays taxes on capital?

k

r

r0

r1

k1

ks

kd

tw, ts

E0

E1

k0 k

r

r0

r1

k1

ks

kd

tis

E0

E1

k0

A tax on household capital income A rise in the corporate income tax

In both cases the capital stock decreases, which affects labour productivity and hence

labour income.

In an open economy setting capital supply is very elastic (at the limit infinitely elastic at

the prevailing interest rate r. A tax on corporate income is entirely borne by labour.

Social losses and distortions

A consumption tax Social losses

pisani-ferry december 2010 30

Q

P

D

B C

Supply

Demand

E

A

F

Q0Q1

P0

P1s

P1d

t

Surplus Without

tax

With tax Difference

Consumers A+B+C A -(B+C)

Producers D+E+F F -(D+E)

Government 0 B+D + (B+D)

Total A+B+C+

D+E+F

A+B+D+

F

- (C+E)

C + E is the Harberger triangle, whose surface corresponds to the deadweight loss

implied by taxation

Taxation is distortionary

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Computing social losses

• The social loss (the surface of the Harberger triangle) is:

• Implications

– Distortions are quadratic in the tax rate

– Distortions on high-elasticity goods are higher

• Minimising distortions leads to the Ramsey rule which states

that taxation should be inversely proportional to tax

elasticities:

• This may conflict with equity (leads to tax essential goods,

unskilled labour rather than capital, etc..)

pisani-ferry december 2010 31

+=

sdk

p

t

εε

11

+=

DS

DS

P

QtL

εε

εε

0

02

2

1

Taxation, incentives and tax returns:

The Laffer curve

pisani-ferry december 2010 32

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pisani-ferry december 2010 33

Theory and practice

Tax rate

Tax

receipts

10

15

20

25

30

35

1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Ivanova, Keen and Klemm (2005).

To

p m

arg

ina

l P

IT r

ate

(%

)

2,2

2,4

2,6

2,8

3

3,2

3,4

3,6

PIT

reve

nu

es (%

of G

DP

)

Top marginal tax rate (%) PIT revenues (% of GDP)

The Russian 2001 tax reform

However the claim that in the 1970s the US was in the prohibitive range proved unfounded

pisani-ferry december 2010 34

Optimal taxation

Mirlees (1971) : addresses the efficiency-equity trade-off through maximising social

utility subject to income and incentive constraints

– Utility: weighted average of individual utilities (giving more weight to the poor)

– Income: revenue to be raised

– Incentive: efficiency dimensions

Assumes population is a continuum of individuals indexed by productivity w.

Question: should one tax the low-productivity individuals (for efficiency) or the high-

productivity ones (for equity?)

– T’(w) : Marginal tax rate for individuals whose productivity is w ;

– E(w) : decreasing function of the elasticity of labour supply (Ramsey principle);

– R(w) : weight of w-productivity individuals in the social utility function;

– H(w) : structure of the population (decreases with the size of the w-productivity

population; increases with the size of the population whose productivity exceeds w) ;

– F(w) cumulated distribution

)()()()('1

)('wHwRwE

wT

wT=

− )(

)(1)(

wwf

wFwH

−=

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Implications

• Mirlees results:

– Optimal tax rate is approximately linear (constant marginal rate)

– Marginal tax rates are rather low

– Limited redistributive properties

• Results however depend on social utility

• Refined versions of Mirlees model result in U-shaped marginal taxation schedule

pisani-ferry december 2010 35

Tax rate Average Marginal

Median 6 21

Top decile 14 20

Top percentile 16 17

Source: Atkinson and Stiglitz, 1980

Corrective taxation

• In the presence of market failures (when agents do not

internalise externalities) Pigouvian taxation helps aligning

private costs with social costs

• Examples

– Tax on London chimneys (Pigou 1920)

– London congestion charge

– Carbon taxes

– Transaction taxes?

• Goal is not to raise revenue but to correct incentives

• Pigouvian taxation an alternative to regulation

pisani-ferry december 2010 36

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What to do with the money?

• Pigouvian tax rate should be set in view of incentive objectives, not in view of revenues (optimal rate should be set in order to equalise marginal distortion across taxes)

• Solutions to dispense of revenues– Compensate taxpayers with lump-sum allowance (e.g.

grandfathering for CO2 emissions)

– Reduce other taxes (‘double dividend’), e.g. taxes on labour

– Finance public goods, possibly in the same field (e.g. research on climate change mitigation)

• Successful Pigouvian taxes are expected to shrink the tax base and therefore revenues, so double dividend approach may be self-defeating

pisani-ferry december 2010 37

Taxation in open economies and

tax competition

• Standard taxation models assume goods and factors are immobile

• Mobility (of labour; capital; and goods and services) raises issues of tax

competition

• Applies

– Across jurisdictions within countries (local taxation). Major issue for income taxes,

business taxes

– Across countries. Increasingly significant issue for income taxes, corporate income

taxes

• Tax competition can be viewed:

– A good thing if the government is considered a Leviathan (or just an inefficient government)

– A bad thing if the government is considered benevolent and efficient: reduced provision of

public goods, tax inequality arising from heavier taxation of less-mobile bases (low-skill labor)

pisani-ferry december 2010 38

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Tax competition models

pisani-ferry december 2010 39

Tiebout (1956) :

• N jurisdictions with different tax rates and government services

• Individuals ‘vote with their feet’ and move across jurisdictions. Two effects:

– Eliminates inefficient tax / government service combinations

– Makes room for diversity (individuals group according to preferences)

Zodrow et Mieszkowski (1986):

• If all jurisdictions have similar preferences, provision of government services under

such tax competition will be lower than its optimum

• Validates ‘race to bottom’ view

Bucovetsky et Wilson (1991):

• If capital is mobile and labour is immobile, taxation will fall on labour

Baldwin et al. (2003):

• Agglomeration generates rents that are taxable

• Tax competition a way for peripheral countries to compensate disadvantage

Tax competition in practice: The EU case

Corporate tax rate, 1990-2007 Standard VAT rate, 1982-2010

pisani-ferry december 2010 40

15%

20%

25%

30%

35%

40%

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

Statutory EU15

Effective average EU15

Effective average NMS8

Statutory NMS10

18.0%

18.5%

19.0%

19.5%

20.0%

20.5%

21.0%

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

NMS10

EU15

Source: European Commission

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21

6.1 Issues

• What is taxation about?

• Which taxes?

• Redistribution and efficiency

6.2 Theories

• Tax incidence

• Social losses and distortions

• Optimum taxation

• Corrective taxation

• Taxation in open economies

6.3 Policies

• Efficiency

• Equity

• International coordination

pisani-ferry december 2010 41

Theory and policy

• Tax policy less influenced by economic theory than decisions

in other policy fields

• Examples:

– Bush tax cuts

– French VAT cut for restaurants

• Why?

– Some straightforward recommendations, but

– Other concerns (ex: ‘un vieil impôt est un bon impôt’)

– Tax theory concepts difficult to grasp (tax incidence)

pisani-ferry december 2010 42

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pisani-ferry december 2010 43

Efficiency

Equivalence principle

• where WP is real cost of labour for the employer, Ω is net real income for the employee

• Labour demand and supply elasticitities command the variations of Ω and W/P in response to changes in tax rates (tax incidence)

Ignores that VAT is also paid on capital income and pension income (but investment isexempted from VAT)

Equivalence only applies in the long run (in the short run rigidities matter)Example: Germany 2007 • Initially lowering of social security contributions and raise of VAT• Later on led to demands for wage increases

Special cases:• Minimum wage (in France, set in real terms net of social security contributions but

gross of VAT)• Open economy

P

W

tt

tt

VATSSC

PITSSC

)1)(1(

)1)(1(

1

2

++

−−=Ω

pisani-ferry december 2010 44

Case study: VAT vs social contributions

First step: Y = C

• the VAT base is Y ;

• if the share of labor in value added is 2/3, the social contribution base is 2Y/3 ;

• to raise receipts of Y/5, you need a 20% VAT rate or a 30% SC rate: VAT less distorsionary (Ramsey rule).

Second step: Y = C + I

• if the share of labor in value added is 2/3, the VAT base shrinks to 2/3 Y ;

• the social contribution base is still 2Y/3

• to raise receipts of Y/5, you need a 30% VAT rate or a 30% SC rate: the two levies are equivalent.

• this corresponds to the golden rule of growth where I/Y = rK/Y = 1- wL/Y

Third step: Y = C + I + X - QM

• unchanged VAT receipts if X = QM, higher receipts if X < QM (trade deficit) ;

• however foreign suppliers may reduce their export prices following a VAT

Conclusion: impact of a substitution of VAT for employers’ contributions

• short run: increased competitiveness, reduced purchasing power

• long run: increased net wages, no impact on competitiveness neither on purchasing power (except

incomplete pass-through from foreign suppliers and/or distributional effects across industries)

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In practice VAT increasingly popular

pisani-ferry december 2010 45

General consumption taxes in OECD countries, percentage of total

revenues, 2007

0

5

10

15

20

25

30H

un

ga

ry

Ice

lan

d

Ire

lan

d

Po

rtu

ga

l

Ne

w-Z

ea

lan

d

Po

lan

d

Gre

ece

Slo

va

k R

ep

.

De

nm

ark

Turk

ey

Me

xico

Ne

the

rla

nd

s

Fin

lan

d

Ge

rma

ny

Sw

ed

en

No

rwa

y

EU

15

un

we

igh

ted

OE

CD

un

we

igh

ted

Au

stri

a

UK

Cze

ch R

ep

.

Fra

nce

Be

lgiu

m

Sp

ain

Ko

rea

Luxe

mb

ou

rg

Ita

ly

Ca

na

da

Sw

itze

rla

nd

Au

stra

lia

Jap

an

% o

f to

tal

tax

re

ve

nu

es

Source: OECD

pisani-ferry december 2010 46

Case study: VAT vs sales taxAssumptions

• A producer of an intermediate input sells for EUR 100 to a producer of a final good

• The producer of the final good sells for EUR 150 to a final consumer

VAT 20%

• the intermediate input producer charges a EUR 20 VAT;

• the final good producer charges a EUR 30 VAT and recovers EUR 20 on his purchase of the

intermediate good;

• tax receipt: EUR 30.

Sales tax 20%

• the intermediate input producer does not charge any tax;

• the final good producer charges a EUR 30 sales tax;

• tax receipt: EUR 30.

Advantage of the VAT over the sales tax

• in case one producer in the value-added chain omits to declare VAT, the latter will be charged at

a later stage of the chain; there is an incentive for each firm to declare its purchases;

• however fraud on VAT is widespread (up to10% of the receipts in some Member states).

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pisani-ferry december 2010 47

Number of countries with VAT

pisani-ferry december 2010 48

Efficiency: the CIT case

Should firms’ profits be taxed?

•Useless is final incidence is on labor;

• Better tax capital income at the household level (less mobile than capital itself).

Justifications to CIT:

• Corporate income easier to track at the source than at the residence level;

• Try to tax only rents;

•The only way to tax foreign shareholders;

• Save the personal income tax (what if households become firms?);

• Political economy: firms don’t vote.

However the CIT raises some difficulties

• Source or residence principle? (how to tax affiliates’ benefits)

• Base: stock return (exemption of interests on debt), capital return (taxation of interests) or

just rents (exemption of interests and of « normal » dividends?

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pisani-ferry december 2010 49

Equity

progressive or flat tax ?

Bourguigon & Chiappori (1998,

France) : PIT, constant rate of

35% necessary to fund a

universal income of 4500 euros

for a single.

Georges W. Bush (2001, 2003,

USA): unfunded tax cuts

pisani-ferry december 2010 50

The flat tax

Flat tax adopted Personal income tax rates Corporate income

tax rate, after

reform

Change in basic

allowance After Before

Estonia 1994 26 16-33 26 Modest increase

Lithuania 1994 33 18-33 29 Substantial increase

Latvia 1997 25 25 and 10 25 Slight reduction

Russia 2001 13 12-30 37 Modest increase

Ukraine 2004 13 10-40 25 Increase

Slovak Rep. 2005 19 10-38 19 Substantial increase

Georgia 2005 12 12-20 20 Eliminated

Romania 2005 16 18-40 16 Increase

Note: Most countries do not apply pure flat tax systems since the flat rate does not apply to all tax bases. For

instance, social insurance contributions are levied separately. To the extent that these contributions exceed the

present value of future (contingent) social benefits, the system is not neutral, since labor and capital income are

not taxed equally. See OECD (2006).

Source: Keen et al. (2006).

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pisani-ferry december 2010 51

Example: the 2001 reform in Russia

Marginal and average tax rates before and after Russian tax reform

0%

5%

10%

15%

20%

25%

30%

35%

1 20000 40000 60000 80000 100000 120000 140000 160000 180000 200000

Ivanova, Keen and Klemm (2005).

Marginal 2000 Marginal 2001 Average 2000 Average 2001

Household income in rubbles

pisani-ferry december 2010 52

Equityaverage PIT and social contributions in 3 countries

0

10

20

30

40

50

60

70

P0-90 P90-95 P95-99 P99-99.5 P99.5-99.9 P99.9-99.99 P.99.99-100

Percentiles of the population

Avera

ge t

ax r

ate

in %

PIT 1970 PIT 2004 Payrolls 1970 Payrolls 2000

Source: Piketty and Saez (2007).

0

10

20

30

40

50

60

70

P0-90 P90-95 P95-99 P99-99.5 P99.5-99.9 P99.9-99.99 P.99.99-100

Percentiles of the population

Avera

ge t

ax r

ate

in %

PIT 1970 PIT 2004 Payrolls 1970 Payrolls 2004

Source: Piketty and Saez (2007).

0

10

20

30

40

50

60

70

P0-90 P90-95 P95-99 P99-99.5 P99.5-99.9 P99.9-99.99 P.99.99-100

Percentiles of the population

Ave

rag

e t

ax

rate

in

%

PIT 1970 PIT 2005 Payrolls 1970 Payrolls 2005

Source: Piketty and Saez (2007).

France

UK USA

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pisani-ferry december 2010 53

Equity: inter-temporal aspectsimpact of 2001-2006 tax cuts in the United States

Percentage change of after-tax income, in 2006

0

1

2

3

4

5

6

7

1st

quintile

2nd

quintile

3rd

quintile

4th

quintile

5th

quintile

Top 10% Top 5% Top 1% Top

0,5%

Top

0,1%

Source: Leiserson and Rohaly (2006).

Percentage change in after-tax income for various percentiles of the population, 2010

-20

-15

-10

-5

0

5

10

1st

quintile

2nd

quintile

3rd

quintile

4th

quintile

5th

quintile

Top 10% Top 5% Top 1% Top

0,5%

Top

0,1%

Source: Leiserson and Rohaly (2006).

No financing Lump-sum financing

Financing proportional to income Financing proportional to tax liability

Direct effect Accounting for financing

pisani-ferry december 2010 54

Horizontal equity: capital income

• Avoid double taxation (labor income, capital income) :

payment in full discharge, tax credit, dual tax (Sweden).

• Distortion between tax treatment of interests and dividends

(CIT)

• Distortion between physical and human capital

• Tax expenditure = 20% of tax receipts in France, 40% in Spain,

50% in the United States.

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pisani-ferry december 2010 55

Collection costs

Tax administration costs in percentage of net tax receipts, 1997

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

1,8

Unite

d Sta

tes

Swed

en

Ireland

Spain

Canad

aUK

Net

herla

nds

Italy

Fran

ce

Ger

man

y

Source: Lépine (1999).

United States:

For each dollar of

tax, 22 cents paid to

layers or advisers

(average, source

Hodge et al. 2005).

Alternative

minimum tax.

pisani-ferry december 2010 56

European tax coordination

• VAT: « transitory » regime (since1993) :

– Origin principle only for across-the-border purchases by households, mail-order selling and cars;

– Destination principle: general case (carrousel fraud ≅ 10% in some Member states).

• Taxation of personal capital income (January 2003) :

– « Tax package » = exchange of information (after a delay an conditional on agreements with tax heavens) + code of conduct (harmful practices)

• CIT

– « Mother-affiliate » directive against double-taxation of repatriated profits;

– Ruding report (1992): minimum tax rate

– Base harmonization and consolidation (October 2001). Enhanced cooperation? 2008.

• A European tax?

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pisani-ferry december 2010 57

Standard VAT rates in 2008

10%

12%

14%

16%

18%

20%

22%

24%

Den

mar

k

Swed

en

Finland

Polan

d

Belgium

Ireland

Portu

gal

Austri

aIta

ly

Bulga

ria

Hun

gary

Slove

nia

Franc

e

Ger

man

y

Gre

ece

Net

herla

nds

Cze

ch R

ep.

Rom

ania

Slova

kia

Eston

ia

Latvia

Lith

uania

Malta U

K

Spain

Luxe

mbo

urg

Cyp

rus

Source: European Commission (2008).

References

• Atkinson, A. (1977), “Optimal Taxation and the Direct versus Indirect Tax Controversy,” Canadian Journal of Economics, 10, pp. 590–606.

• Atkinson, A., T. Piketty and E. Saez (2010), “Top income in the long run of history”, mimeo, http://piketty.pse.ens.fr/fichiers/public/AtkinsonPikettySaez2010.pdf

• Baldwin, R., R. Forslid, P. Martin, G. Ottaviano, and F. Robert-Nicoud (2003), Economic Geography and Public Policy, Princeton University Press.

• Bourguignon, F., and D. Bureau (1999), “L’architecture des prélèvements obligatoires en France: état des lieux et voies de réforme,” Rapport pour le Conseil d’Analyse Economique, no. 17, Paris: La Documentation Française.

• Bourguignon, F., and P.-A. Chiappori (1998), “Fiscalité et redistribution,” Revue Française d’Economie, 13, pp.1–64.

• Bucovetsky, S., and J.D. Wilson, (1991), “Tax Competition with Two Tax Instruments,” Regional Science and Urban Economics, 21, pp. 333–50.

• Laffer A. (2004), “The Laffer Curve: Past, and Present Future,” Backgrounder no. 1765, Washington DC: The Heritage Foundation, available at www.heritage.org.

• Mirrlees, J. (1971), “An Exploration of the Theory of Optimal Income Taxation,” Review of Economic studies, 38, pp. 175–208.

• Olson, M. (1969), “The Principle of ‘Fiscal Equivalence’: The Division of Responsibilities among Different Levels of Government,” American Economic Review, 59, pp. 479–87.

• Salanié, B. (2003), The Economics of Taxation, MIT Press.

• Tiebout, Ch. (1956), “A pure theory of local expenditures,” Journal of Political Economy, 64, pp. 416–24.

• Zodrow, G., and P. Mieszkowski (1986), “Pigou, Tiebout, Property Taxation, and the Underprovision of Local Public Goods,” Journal of Urban Economics, 19, pp. 356–70.

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