Econ 208 Marek Kapicka Lecture 9 Taxation. Midterm in a week! I’ll post older midterms Some Multiple Choice questions 2 longer questions Similar to PS1,

Econ 208

Marek KapickaLecture 9Taxation

Midterm in a week! I’ll post older midterms Some Multiple Choice questions 2 longer questions

Similar to PS1, PS2, PS3, Q1-2 in Mid 2011, Q1-2 in Mid 2010

Know: competitive equilibrium: how to solve, what each step MEANS.

Know: Pareto Optimum Today’s class will be included. Wednesday

will not.

Where are we?

1. Introduction: A model with no Government

2. Government Policies1. The Effects of Government Spending2. Government Taxation and Government

Debt

What To Read

Read Today:

DLS, Chapter 13.2,13.4 The Region, Minneapolis Fed: “European

Vacation”, on the web Next time:

The Washington Post:"Where does the Laffer curve bend? "

Today

Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government

Revenue 4) The effects on GDP

Data on US TaxationFederal Government Revenue

Data on US TaxationAverage Marginal Income Taxes

Taxation

Lump-Sum tax vs. Distortive tax Lump sum tax does not depend on

the actions of the consumer With distortive taxation, the

welfare theorems fail Competitive equilibrium is not Pareto

optimal

Why Distortive Taxation? In reality, lump-sum tax is infeasible

Lump sum means everyone pays the same amount but some people have no wealth

If differences among people are taken into account then a distorting tax is the only possibility

What are the effects of a flat tax on Labor Supply? Government Revenue? GDP? Capital Accumulation?

Where we are

Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government

Revenue 4) The effects on GDP

2) The Effects on Labor SupplyAn Example

Utility of a household

Household problem:

1),(

1LCLCU

wLtCts

LC

)1( ..

1max

1

2) The Effects on Labor Supply

Solution:

Labor Supply decreases in the tax rate

1)1(max

1LwLt

L

1

])1[( wtL

The model and the data E. Prescott (2004). “Why Do Americans Work So Much More Than Europeans?

U.S. vs. France

1990’s: French productivity higher, but labor

supply much lower GDP per person lower in France than

in the USA 1970’s:

French productivity lower, but labor supply slightly higher

Ohanian, Raffo, Rogerson: A more comprehensive study

Compare all the OECD countries for 1956-2004 period

How much can we explain by taxes?

Look for alternative explanations as well.

Conclusion: Taxes are the most important factor behind changes in labor supply

Ohanian, Raffo, Rogerson: The data

Ohanian, Raffo, Rogerson: The Results

Ohanian, Raffo, Rogerson: Other Factors

Compute a labor supply wedge:

Our model predicts that the wedge is equal to the tax rate. What if other factors, outside of the model, affect it as well?

Look at measure of employment protection, union density, unemployment benefit replacement rate, duration benefits

Δ𝑡=1−𝑀𝑅𝑆𝑙 ,𝑐

𝑀 𝑃𝑁

Ohanian, Raffo, Rogerson: Other Factors

3) The Effects on Tax Revenue

Government’s Tax revenue

Revenue is not linear in the tax rate!

If tax rate increases, Tax per one unit of labor supply

increases but labor supply decreases

11

)1( wtttwLT

Laffer Curve

Government’s revenue against the tax rate

t

T

0% 100%11+1/𝛾

Empirical Evidence

1981 Reagan Tax Cuts Overall, tax revenues have decreased However, for the tope earners the tac

cuts have raised collections Maximum tax rate: 70% 50% Increase in revenue from top (>200000)

earners: 3% in 1982 9% in 1983 23% in 1984

4) The Effect on GDP

Christina Romer/ David Romer Classify all tax changes into

Endogenous tax changes: Spending driven tax changes Recession driven tax changes

Exogenous tax changes Belief motivated tax cuts Deficit driven tax increases

Only exogenous tax changes will identify the effect on GDP

A timeline of tax changes

Exogenous tax changes

Endogenous tax changes

A response to a tax increase of 1% of GDP

Main result

Tax increases have large negative effects on output/ labor supply