Empirical Evidence and Earnings Taxation:
Lessons from the Mirrlees Review
ES World Congress
August 2010
Richard Blundell
University College London and Institute for Fiscal Studies
© Institute for Fiscal Studies
Empirical Evidence and Earnings Tax Design:
L
Lessons
from
f
the
h Mirrlees
Mi l
Review
R i
•
The role
Th
l off evidence
id
is
i loosely
l
l organised
i d under
d five
fi
headings:
1. Key margins of adjustment to tax reform
2. Measurement of effective tax rates
3 The importance of information,
3.
information complexity and
salience
4. Evidence on the size of responses
5 Implications
5.
I li i
for
f tax design
d i
Increased empirical knowledge: – some examples
•
labour supply responses for individuals and families
– at the intensive and extensive margins
•
taxable income elasticities
– top of the income distribution using tax return information
•
consumer responses to indirect taxation
– nonseparability with leisure and variation in price elasticities
•
income uncertainty
– persistence & magnitude of earnings shocks over life-cycle
•
ability to (micro
(micro-)simulate
)simulate marginal and average rates
– simulate ‘optimal’ reforms
Key Margins of Adjustment
•
Extensive and intensive margins of labour supply
– Both margins both matter
– Theyy matter for tax p
policy
y evaluation and design
g
– And they matter empirically in different ways by
age and demographic groups
Employment for men by age – FR, UK and US 2007
100%
90%
FR
UK
US
80%
70%
60%
50%
40%
30%
20%
10%
0%
16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74
Blundell, Bozio and Laroque (2010)
Extensive and intensive margins for women
Female Employment
p y
byy age
g – US,, FR and UK 2007
0.90
0.80
FR
UK
US
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
16
18 20 22 24
26 28 30 32
34 36 38 40
42 44 46 48
50 52 54 56
58 60 62 64
Blundell, Bozio and Laroque (2010)
66 68 70 72
74
Female Hours by age – US, FR and UK 2007
1600
FR
1400
UK
US
1200
1000
800
600
400
200
0
16
18
20
22
24
26
28
30
32
34
36
38
40
42
44
46
48
50
52
54
56
58
60
Blundell, Bozio and Laroque (2010)
62
64
66
68
70
72
74
Female Hours by age – US, FR and UK 1977
1600
FR
1400
UK
US
1200
1000
800
600
400
200
0
16
18
20
22
24
26
28
30
32
34
36
38
40
42
44
46
48
50
52
54
56
58
60
Blundell, Bozio and Laroque (2010)
62
64
66
68
70
72
74
The extensive – intensive distinction is important
for a number
n mber of reasons
•
Understanding responses to tax and welfare reform
– Heckman, Rogerson, Wise, .. all highlight the
importance of extensive labour supply margin
•
The extensive and intensive elasticities are also key
parameters in the recent literature on tax design
–
referenced heavily in this Review.
Why is this distinction important for tax design?
•
A ‘large’ extensive elasticity at low earnings can ‘turn
around’ the impact of declining social weights
– implying
i l i a hi
higher
h ttransfer
f tto llow earning
i workers
k
th
than
those out of work – potentially a role for earned
income tax credits
• But how do individuals perceive the tax rates implicit in
y
- salience?
the tax credit and benefit systems
– are individuals more likely to ‘take-up’ if generosity
increases?
– suggests a move to a ‘single integrated family benefit’
– we argue
g it is more difficult to integrate
g
benefits with
the tax system
g
other than labour supply/hours
y
• Importance of margins
– use of taxable income elasticities
Focus first on tax rates on lower incomes
P
Possible
ibl defects
d f t in
i currentt welfare/benefit
lf /b
fit systems
t
• Participation tax rates (PTRs) and effective marginal tax
rates (EMTRs) at the bottom remain very high in UK and
elsewhere
• EMTRs are well over 80% for some low income working
families
– because of phasing-out
phasing out of the various means
means-tested
tested
benefits and tax credits
– and overlap of these with the income tax system
40%
4
50%
%
60%
70%
80
0%
Average EMTRs across the earnings distribution for different
family types
0
100
200
300
400
500
600
700
800
900
1000 1100 1200
Employer cost (£/week)
Single, no children
P
Partner
not working,
ki
no children
hild
Partner working, no children
Lone parent
P
Partner
not working,
ki
children
hild
Partner working, children
Mirrlees Review (2010)
What about the size of labour supply responses?
Structural Model Elasticities – low education lone parents
((b)) Youngest
g
Child Aged
g 4-11
Weekly
Earnings
0
Density
Extensive
Intensive
0.380
0
380 ((.020)
020)
0.321 (.009)
0 172 ((.005)
0.172
005)
0.068 (.003)
0 820 ((.042)
0.820
042)
0.085
0
08 ((.009)
009)
0.219 (.025)
0 194 ((.020)
0.194
020)
0.102 (.010)
0.4327
50
0
01
0.1575
150
0.1655
250
0 1298
0.1298
350
0.028
Employment elasticity
Blundell and Shephard (2010)
Structural Model Elasticities – low education lone parents
(c) Youngest Child Aged 0-3
Weeklyy
Earnings
Densityy
Extensive
Intensive
0
0.5942
50
0.1694
0.168 (.017)
0.025 (.003)
150
0 0984
0.0984
0 128 ((.012)
0.128
012)
0 077 ((.012)
0.077
012)
250
0.0767
0.043 (.004)
0.066 (.010)
350
0 0613
0.0613
0 016 ((.002)
0.016
002)
0 035 ((.005)
0.035
005)
Participation elasticity
0.536 (.047)
Blundell and Shephard (2010)
• Differences in intensive and extensive margins by age and
demographic composition can have important implications for
the design of the tax schedule...
Implications for Tax Reform
• Change transfer/tax rate structure to match lessons from
‘new’ optimal tax analysis and empirical evidence:
• Lower marginal rates at the bottom
– means-testing should be less aggressive
– at least for some key groups =>
• Age-based taxation
– distinguish by age of youngest child for mothers/parents
– pre-retirement ages
– points to a ‘life-cycle’ rearrangement of tax incentives and
benefit payments to match elasticities
– empirical
p
results suggest
gg
significant
g
increases in
employment and earnings
Top tax rates and taxable income elasticities
A revenue maximising top bracket tax rate:
t = 1 / (1 + a·e)
a - is the Pareto parameter
e - taxable income elasticity
Pareto distribution as an approximation to the income distribution
Pro
obability density ( log scale )
0.0100
0.0010
Pareto distribution
Actual income distribution
0.0001
0.0000
0.0000
£100 000 £150,000
£100,000
£150 000 £200,000
£200 000 £250,000
£250 000 £300,000
£300 000 £350,000
£350 000 £400,000
£400 000 £450,000
£450 000 £500,000
£500 000
Pareto parameter quite accurately estimated at 1.8
Taxable Income Elasticities at the Top (UK)
Simple Difference
(top 1%)
1978 vs 1981
0.32
1986 vs 1989
0.38
1978 vs 1962
0.63
2003 vs 1978
0.89
Full time series
0.69 (.12)
DiD using
(top 5-1%
5 1% as control)
0.08
0.41
0.86
0.64
0.46 (.13)
=> revenue maximising tax rate for top 1% of ≈ 55%.
- Note also the key relationship between the size of
elasticity
y and the tax base
=> capital gains tax reforms, etc
Implications for Tax Reform
• Key role of labour supply responses at the extensive and
intensive margins
– both matter but differ by gender, age, ed. and composition
• Results suggest
gg
lower marginal
g
rates at the bottom
– means-testing should be less aggressive
– at least for some key low income groups
• Reduce complexity of benefit and tax credit system
– move to a single integrated family benefit
• Taxable income elasticities at the top
– limited room for tax rate rises without changes to tax base
• Endogenous family composition and dynamics?
Empirical Evidence and Earnings Taxation:
L
Lessons
ffrom th
the Mi
Mirrlees
l
R
Review
i
Five building blocks for the role of evidence in tax design
design….
•
Key margins of adjustment to tax reform
•
Measurement of effective tax rates
•
The importance of information
information, complexity and salience
•
Evidence on the size of responses
•
Implications for tax design
•
Additional role for earnings tax design to undo the
distributional effects of the rest of the reform package …
S hhttp://www.ifs.org.uk/mirrleesReview
See
//
if
k/ i l R i
© Institute for Fiscal Studies
Some Additional References (in addition to papers in the
Dimensions volume)
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Blundell, R. (2006), “Earned income tax credit policies: Impact and Optimality”,
The 2005 Adam Smith Lecture,
Lecture Labour Economics,
Economics 13,
13 423
423-443.
443
Blundell, R, Bozio, A. and Laroque, G.(2010), “The extensive and intensive
margins of labour supply: Hours worked in the US
US, UK & France"
France , mimeo,
mimeo IFS
IFS.
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i L
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U
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i
it off Chi
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p
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ll H
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i
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