Empirical Evidence and Tax
Policy Design: Lessons from the
Mirrlees Review
JEEA - Foundation BBVA Lecture
AEA Meetings, Atlanta
January 3rd 2010
Richard Blundell
University College London and Institute for Fiscal Studies
(longer version of lecture on AEA conference website)
© Institute for Fiscal Studies
Empirical Evidence and Tax Policy Design
•
First, a little background to the Mirrlees Review
•
Then a discussion on the role of evidence loosely
organised under five headings:
1. Key margins of adjustment to tax reform
2. Measurement of effective tax rates
3. The importance
p
of information,, complexity
p
y and salience
4. Evidence on the size of responses
5. Implications for tax design
•
Focus on earnings,
g , savings
g and indirect tax reform as
leading examples
The Mirrlees Review
Reforming the Tax System for the
21st Century
Editorial Team
Chairman: Sir James Mirrlees
y ((LSE, Bank of England
g
& IFS))
Tim Besley
Richard Blundell (IFS & UCL)
Malcolm Gammie QC (One Essex Court & IFS)
James Poterba (MIT & NBER)
with:
Stuart Adam (IFS)
Steve Bond (Oxford & IFS)
Robert Chote (IFS)
Paul Johnson (IFS & Frontier)
Gareth Myles (Exeter & IFS)
The Mirrlees Review
• Review of tax design from first principles
– For
F modern
d
open economies
i iin generall
– For the UK in particular
• Two volumes:
- ‘Dimensions
Dimensions of Tax Design’:
Design : a set of 13 chapters on
particular areas co-authored by IFS researchers +
international experts, along with expert
commentaries (MRI)
- ‘Tax
Tax by Design’:
Design : an integrated picture of tax design
and reform, written by the editors (MRII)
– http://www.ifs.org.uk/mirrleesReview/publications
htt //
if
k/ i l
R i / bli ti
• MRI on the web and now at the OUP stand…
Dimensions of Tax Design: commissioned chapters
and expert commentaries (1)
•
•
•
The base for direct taxation
James Banks and Peter Diamond; Commentators: Robert Hall; John
K
Kay;
Pierre
Pi
P
Pestieau
ti
Means testing and tax rates on earnings
Mike Brewer
Brewer, Emmanuel Saez and Andrew Shephard; Commentators:
Hilary Hoynes; Guy Laroque; Robert Moffitt
Value added tax and excises
IIan Crawford,
C
f d Michael
Mi h l K
Keen and
d St
Stephen
h S
Smith;
ith C
Commentators:
t t
Richard Bird; Ian Dickson/David White; Jon Gruber
•
Environmental taxation
Don Fullerton, Andrew Leicester and Stephen Smith; Commentators:
Lawrence Goulder; Agnar Sandmo
•
Taxation of wealth and wealth transfers
Robin Boadway, Emma Chamberlain and Carl Emmerson;
y Martin Weale
Commentators: Helmuth Cremer; Thomas Piketty;
Dimensions of Tax Design: commissioned chapters
and expert commentaries (2)
•
•
International capital taxation
Rachel Griffith,, James Hines and Peter Birch Sørensen;; Commentators:
Julian Alworth; Roger Gordon and Jerry Hausman
Taxing corporate income
Alan Auerbach
Auerbach, Mike Devereux and Helen Simpson; Commentators:
Harry Huizinga; Jack Mintz
•
Taxation of small businesses
Claire Crawford and Judith Freedman
•
The effect of taxes on consumption and saving
Orazio Attanasio and Matthew Wakefield
•
Administration and compliance, Jonathan Shaw, Joel Slemrod and John
Whiting; Commentators: John Hasseldine; Anne Redston; Richard
Highfield
•
Political economy of tax reform, James Alt, Ian Preston and Luke
Sibieta; Commentator: Guido Tabellini
Why another Review?
Changes in the world (since the Meade Report)
Changes in our understanding (..)
I
Increased
d empirical
i i l kknowledge
l d ((..))
Increased empirical knowledge: – some examples
•
labour supply responses for individuals and families
– at the intensive and extensive margins
– by age and demographic structure
•
taxable income elasticities
– top of the income distribution using tax return information
•
consumer responses to indirect taxation
– importance of nonseparability and variation in price elasticities
•
i t t
intertemporal
l responses
– consumption, savings and pensions
•
Income uncertainty
– persistence and magnitude of earnings shocks over the life-cycle
•
ability to (micro-)simulate marginal and average rates
– simulate ‘optimal’ reforms
Empirical Evidence and Tax Policy Design
1. Key margins of adjustment to tax reform
2 Measurement of effective tax rates
2.
3. The importance of information, complexity and salience
4. Evidence on the size of responses
5 Implications
5.
I li ti
ffor tax
t design
d i
g , indirect and savings
g taxation:
Here I will focus on earnings,
•
Leading examples of the mix of theory and evidence
•
Key implications for tax design
•
Earnings taxation
taxation, in particular
particular, takes most of the strain in
distributional adjustments of other parts of the reform package
Key Margins of Adjustment
• Intensive and extensive margins of
labour supply
• Taxable income and forms of remuneration
• Consumer demand mix
• Savings
Savings-pension
pension portfolio mix
• Housing equity
• Human capital
• Organisational form
• Debt-equity mix for companies
• Company/R&D location
Key Margins of Adjustment
•
Extensive and intensive margins of labour
supply
•
What do they look like?
–
G tti
Getting
it right
i ht for
f
men
Male Employment by age – US, FR and UK
2007
100%
90%
80%
FR
UK
US
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
Bozio, Blundell and Laroque
Male Employment by age UK: 1975 - 2005
1
1975
1985
1995
2005
0.9
0.8
0.7
0.6
05
0.5
0.4
03
0.3
0.2
0.1
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
Data: UK LFS.
Bozio, Blundell and Laroque
Male Hours by age – US, FR and UK 2005
2200
2000
1800
1600
FR
UK
US
1400
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 62 64 66 68 70 72 74
Bozio, Blundell and Laroque
Key Margins of Adjustment
•
Extensive and extensive margins
•
do they l
What d
look
k l
like?
ke
–
Female employment and hours
Female Employment by age in the UK – 1975
- 2005
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
16
18
20
22
24
26
28
30
32
34
36
38
40
1975
42
44
1985
46
48
1995
50
52
54
56
58
60
62
64
66
68
70
72
74
2005
Source: LFS.
Bozio, Blundell and Laroque
Female Hours by age – US, FR and UK 2005
1400
FR
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 62 64 66 68 70 72 74
Bozio, Blundell and Laroque
Why is this important for tax design?
Implications for the design of tax rates on earnings
1. Suggests where should we look for responses to tax reform.
2 Some key lessons from recent tax design theory (Saez
2.
(Saez,.. )
• Importance of extensive labour supply margin (Heckman,
Rogerson Wise
Rogerson,
Wise, ..))
• A ‘large’ extensive elasticity can ‘turn around’ the impact of
g social weights
g
declining
–
implying a higher transfer to low wage workers than those out of work
–
a role for tax credits
3. But how do individuals perceive the tax rates on earnings
implicit in the tax credit and benefit system - salience?
-
are individuals more likely to ‘take-up’ if generosity increases?
-
how does labour supply in couples respond?
4 Importance of margins other than labour supply
4.
–
taxable income elasticities (at the top)
Top incomes and taxable income elasticities
A . T o p 1 % In c o m e S h a re a n d M T R , 1 9 6 2 -2 0 0 3
80%
16%
70%
14%
12%
T o p 1% M T R
50%
T o p 1 % in c o m e s h a re
40%
10%
30%
8%
Income S
Share
Marginal Ta
ax Rate
60%
20%
6%
10%
2002
2
1998
1
1994
1
1990
1
1986
1
1982
1
1978
1
1974
1
1970
1
1966
1
4%
1962
1
0%
Source: MR, UK SPI (tax return data)
(Some other) Key Margins of Adjustment
•
Consumer demand responses
–
•
Savings-pension portfolio mix
–
•
CGT reforms and the non-alignment with labour income rates
Organisational form
–
•
‘Life-cycle’ accumulation of savings and pension contributions
Forms of remuneration
–
•
responses to differential taxation of across commodities
UK chart on incorporations and tax reforms
Look in the Review documents….
Consumer demand behaviour
•
Three key empirical observations:
•
N
Non-separabilities
biliti with
ith llabour
b
supply
l are iimportant
t t
•
–
but mainly for childcare and work related expenditures
–
updated evidence in MRI
Price elasticities differ with total expenditure/wealth
•
–
responses and welfare impact differs across the distribution
–
new evidence published in Ecta last year
Issues around salience of indirect taxes
–
Chetty et al (AER)
Savings and Pensions
•
When the life-cycle model works
–
How much life-cycle
y
consumption/needs
p
smoothing
g
goes on?
700
3.5
600
3
500
25
2.5
400
2
300
1.5
200
Net Income Per
H
Household
h ld (LH A
Axis)
i )
1
100
Equivalent AdultsPer
Household (RH Axis)
0.5
0
Equiva
alent Adults
s Per Househ
hold
Weekly Income (P
Per Household)
Net Income, Number of Equivalent Adults per
Household
0
20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77
Age of Head
Source: UK FES 1974-2006
Consumption and Needs
3.5
600
Equivilised Non-Durable
Expenditure (LH Axis)
3
500
Equivalent AdultsPer
Household (RH Axis)
2.5
400
2
300
1.5
200
1
100
0.5
0
Numbe
er of Equiv
valent Adullts Per
Hous
sehold
Equiv
vilised Non--Durable Ex
xpenditure
e
(Per Equivalent Adu
ult)
700
0
20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77
A off H
Age
Head
d
Source: UK FES 1974-2006
Savings and Pensions
•
How much life-cycle
life cycle consumption/needs smoothing goes on?
–
permanent/ transitory shocks to income across wealth
distribution ((Blundell,, Pistaferri and Preston ((AER))
))
–
consumption and savings at/after retirement (BBT (AER))
–
how well do individuals account for future changes?
–
•
UK pension reform announcements Attanasio & Rohwedder (AER)
•
Liebman Luttmer & Seif (AER)
Liebman,
Intergeneration transfers - Altonji, Hayashi & Kotlikoff, etc
T
Temporal
l preferences,
f
ability,
bilit cognition,
iti
fframing..
i
–
•
•
Banks & Diamond (MRI chapter); Diamond & Spinnewijn, Saez,..
Earnings/skill uncertainty – across life-cycle and business
cycle
–
Role in dynamic fiscal policy arguments for capital taxation
Kocherlakota; Golosov, Tsyvinski & Werning, ..
Implications for Reform
• Tax Rates on Earnings
• Indirect Taxation
• Corporate Taxation
• Taxation of Savings
• An integrated and revenue neutral
analysis
l i of
f reform…
f
Tax rates on lower incomes
Main defects in current welfare/benefit systems
• Participation tax rates at the bottom remain very high in UK
and elsewhere
• Marginal tax rates in the UK are well over 80% for low
income working families because of phasing-out of meanstested benefits and tax credits
– Working Families Tax Credit + Housing Benefit + etc
– and interactions with the income tax system
– For example, we can examine a typical budget
constraint for a single mother…
The interaction of WFTC with other benefits in the UK
£300 00
£300.00
£250.00
£200.00
WFTC
Income Support
Net earnings
Other income
£150.00
£100.00
£50.00
hours of work
50
45
40
35
30
25
20
15
10
5
0
£0.00
The interaction of WFTC with other benefits in the UK
£300 00
£300.00
£250.00
Local tax rebate
Rent rebate
WFTC
Income Support
Net earnings
Other income
£200.00
£150.00
£100.00
£50.00
50
45
40
35
30
25
20
15
10
5
0
£0.00
hours of work
Strongg
implications
for EMTRs,
PTRs and
labour supply
What about the size of labour supply responses?
Structural Model Elasticities – lower educated lone parents
((a)) Youngest
g
Child Aged
g 11-18
Earnings
0
Density
0 3966
0.3966
Extensive
Intensive
80
140
220
300
0.1240
0.1453
0.1723
0 1618
0.1618
0.5029
0.7709
0.7137
0 4920
0.4920
0.5029
0.3944
0.2344
0 0829
0.0829
Participation elasticity
1.1295
Note: Similar strong extensive margin responses for men in
p
period using
p
g structural retirement models and
‘pre-retirement’
for married women with children.
Blundell and Shephard (2008)
Importance of take-up and information/hassle costs
0
Proba
ability of ttake-up
.2
.4
..6
.8
1
Variation in take-up probability with entitlement to FC/WFTC
0
50
100
150
FC/WFTC entitlement (£/week, 2002 prices)
Lone parents
200
Couples
© Institute for Fiscal Studies
What about the size of labour supply responses?
Structural Model Elasticities – lower educated lone parents
(c) Youngest Child Aged 0-4
Earnings
Density
Extensive
Intensive
0
0.5942
80
0.1694
0.2615
0.2615
140
0 0984
0.0984
0 6534
0.6534
0 1570
0.1570
220
0.0767
0.5865
0.1078
300
0 0613
0.0613
0 4984
0.4984
0 0834
0.0834
Participation elasticity
0.6352
Differences in intensive and extensive margins by age and
demographics
g p
have strong
g implications
p
for the design
g of the tax
schedule... But how reliable are the structural elasticities?
WFTC Reform Evaluation: Matched Difference-inDifferences
Average Impact on % Employment Rate of Single Mothers
Single Mothers Marginal
Effect
Family
3.5
Resources
Survey
Labour Force
3.6
Survey
Standard
Error
1.55
Sample Size
0.55
233,208
25,163
Data: FRS, 45,000 adults per year, Spring 1996 – Spring 2002.
Base employment level: 45% in Spring 1997.
Outcome: employment. Average impact x 100, employment percentage.
Matching Covariates: age, education, region, ethnicity,..
Drop: Summer 1999 – Spring 2000 inclusive
Expenditure on in-work programmes in the UK
E x p e n d itu re (£ m , 2 0 0 2 p ric e s )
7,000
6,000
5,000
,
WFTC
FC
4,000
3,000
2,000
1,000
0
1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 200292
93 94
95
96
97 98
99 2000 01 02
03
The UK Working Families Tax Credit
• Hours condition
– at
t least
l
t 16 or more hours
h
per week
k
• family eligibility
– children (in full time education or younger)
• income eligibility
– if a family's net income is below a certain
threshold
– adult credit plus age-dependent amounts for
each child
– if above a threshold then credit is tapered
away at 55% per extra pound of net income –
previously 70%
The UK Working Families Tax Credit
£6,000
WFTC
£5,000
£4,000
£3,000
£2,000
£1,000
£0
£0
£5,000
£10,000
£15,000
Gross income (£/year)
© Institute for Fiscal Studies
£20,000
£25,000
The US EITC and the UK WFTC compared
£6,000
£5,000
WFTC
£4,000
,
EITC
£3,000
£2,000
£1,000
£0
£0
£5,000
£10,000
£15,000
£20,000
£25,000
Gross income (£/year)
• P
Puzzle:
l WFTC about
b t ttwice
i as generous as th
the US EITC bbutt
with about half the impact. Why?
© Institute for Fiscal Studies
Structural Simulation of the WFTC Reform:
WFTC Tax Credit Reform
All
Change in employment rate:
Average change in hours:
5.95
0 74
0.74
1.79
02
0.2
y-child
0 to 2
3.09
0 59
0.59
0.71
0 14
0.14
y-child
3 to 4
7.56
0 91
0.91
2.09
0 23
0.23
y-child
5 to 10
7.54
0 85
0.85
2.35
0 34
0.34
y-child
11 to 18
4.96
0 68
0.68
1.65
02
0.2
– ‘large’ impact relative to quasi
quasi-experiment
experiment results
Notes: Simulated on FRS data; Standard errors in italics.
Blundell and Shephard (2008)
Structural Simulation of the WFTC Reform:
Impact of all Reforms
All
Change in employment rate:
Average change in hours:
•
•
•
•
3.68
0.84
1.02
0 23
0.23
y-child
0 to 2
0.65
0.6
0.01
0 21
0.21
y-child
3 to 4
4.53
0.99
1.15
0 28
0.28
y-child y-child
5 to 10 11 to 18
4.83
4.03
0.94
0.71
1.41
1.24
0 28
0.28
0 22
0.22
matches with the quasi-experimental results
shows the importance of getting the effective tax rates right
predictions are q
quite accurate
shows the structural model p
also use longer changes in after tax wages across different
groups to identify structural responses (BDM, Ecta 1998)
Hours’ distribution for lone parents, 1990
Blundell and Shephard (2008)
Hours’ distribution for lone parents, 1993
Blundell and Shephard (2008)
Can the reforms explain weekly hours worked?
Single Women (aged 18-45) - 2002
Blundell and Shephard (2008)
An optimal design framework
Social welfare, for individuals of type X
W =∑
∫ε
w, X
*
*
*
Γ
(
U
(
wh
−
T
(
w
,
h
;
X
),
h
; X , ε ))dF (ε )dG(w; X )
∫
where Γ is the ‘social
social welfare
welfare’ transformation.
transformation
The tax structure T(.) is chosen to maximise W, subject
to:
∑∫
*
*
T
(
wh
,
h
; X )dF (ε )dG ( w; X ) = T (= − R )
∫
w, X ε
for a ggiven R.
Control preference for equality by transformation function:
Γ (U | θ ) =
1
(exp U )
{
θ
θ
− 1}
When θ is negative, the function favors the equality of
utilities.
Define u(j) = u(cj , hj ;X,ε). If θ < 0 then the integral
over (Type I extreme
extreme-value)
value) state specific errors is
given by:
1
⎡⎣ Γ (1 − θ ) ⋅ (exp u ( j ))θ − 1⎤⎦
θ
Implied Optimal Schedule, Youngest Child
Aged 0-4
350.00
300.00
250.00
200.00
150.00
100.00
0
50
100
150
No hours rule
200
16 hours rule
250
300
Weekly earnings
March 2002 prices
Blundell and Shephard (2008)
Implied Optimal Schedule, Youngest Child
Aged 5-10
350.00
300.00
250.00
200.00
150 00
150.00
100.00
0
50
100
150
No hours rule
200
16 hours rule
250
300
Weekly earnings
March 2002 prices
Blundell and Shephard (2008)
Implications for Tax Rates
• Change transfer/tax rate structure to match lessons from
‘new’ optimal tax analysis and empirical evidence:
• Lower marginal rates at the bottom
• means
means-testing
testing should be less aggressive
• at least for some groups =>
• Age-based taxation
– distinguish
g
by
y age
g of yyoungest
g
child for
mothers/parents
– pre
pre-retirement
retirement ages
• Hours rules? – at full time, welfare gains depend on monitoring
• Impact of reforms on PTRs and EMTRs (MRII)) →
20%
30%
40%
50%
60%
Effect of child age revenue neutral reforms on average PTRs across the
earnings distribution, by age of youngest child
0
100
200
Notes: Non-par
300
400
500
600
700
800
900
1000 1100 1200
Gross earnings (£/week)
Y
Youngest
t child
hild 0
0-4,
4 before
b f
reform
f
Y
Youngest
t child
hild 0
0-4,
4 after
ft reform
f
Youngest child 5-18, before reform
Youngest child 5-18, after reform
10%
20%
30%
40%
50%
Effect of early retirement revenue neutral reforms on average PTRs across
the earnings distribution, by age
0
100
200
300
400
500
600
700
800
900
1000 1100 1200
Gross earnings (£/week)
Under 55
55, before reform
55-70, before reform
Under 55
55, after reform
55-70, after reform
20%
30%
40%
50%
60%
Effect of early retirement revenue neutral reforms on average EMTRs across
the earnings distribution, by age
0
100
200
300
400
500
600
700
800
900 1000 1100 1200
Gross earnings (£/week)
Under 55,
55 before reform
55-70, before reform
Under 55
55, after reform
55-70, after reform
30%
40%
50%
60%
70%
Effect of child age revenue neutral reforms on average EMTRs across the
earnings distribution, by age of youngest child
0
100
200
300
400
500
600
700
800
900
1000 1100
1200
Gross earnings (£/week)
Youngest child 0-4, before reform
Youngest child 0-4, after reform
Youngest child 5-18, before reform
Youngest child 5-18, after reform
© Institute for Fiscal Studies
Implications for Tax Rates
• These child-age tax reforms redistribute to families with
younger children and increase employment by 40,000,
aggregate
t earnings
i
up by
b £
£.7m
7
• Important employment increases also from pre-retirement
age tax reforms
– retirement incentives highlight the interaction between the taxation of
earnings and the taxation of savings and pensions =>
• Effective tax rates on earnings are a combination of the tax
rate on earnings and on savings/pensions
– how do individual’s p
perceive p
pension contributions?
– assumptions about intertemporal behaviour are so critical
– Leibman, Luttmer and Seif suggest extensive margin... return to this
• What about the design of tax rates on high earnings?
Taxable income elasticities
An ‘optimal’ top tax rate (Brewer, Saez and Shephard, MRI)
e – taxable income elasticity
t = 1 / (1 + a·e) where a is the Pareto parameter.
Estimate e from the evolution of top incomes in tax return
data following large top MTR reductions in the 1980s
( 1.8)) from the empirical
p
distribution
Estimate a(≈
Table: Taxable Income Elasticities at the Top
Simple Difference (top 1%)
1978 vs 1981
1986 vs 1989
1978 vs 1962
2003 vs 1978
F ll titime series
Full
i
DD using top 5-1% as control
0.32
0.38
0.63
0.89
0.08
0.41
0.86
0.64
0.69
0
69
(0.12)
0.46
0
46
(0.13)
With updated data the estimate remains in the .35 - .55 range
with a central estimate of .46,, but remain quite
q
fragile
g
Note also the key relationship between the size of elasticity and
the tax base (Slemrod
(S
and Kopczuk, 2002))
Pareto distribution as an approximation to the income distribution
Pro
obability density ( log scale )
0.0100
Pareto distribution
Actual income distribution
0.0010
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
Change in tax revenue as a result of changing marginal
income tax rate applying to the top 2%
%
Chang
ge in tax re
evenue, £ m
million
£4 000
£4,000
£3,000
£2 000
£2,000
e=0.46
e=0.35
e=0
£1,000
£0
-£1,000
-£2,000
,
-£3,000
-£4,000
30%
35%
40%
45%
50%
Income tax rate
55%
60%
65%
Reforming Tax Rates
• Change transfer/tax rate structure to match lessons from ‘new’
optimal tax analysis
– limits
li it tto ttax rises
i
att th
the ttop, but
b t
• anti-avoidance, domicile rules, .. - tax base reforms
• revenue shifting
hifti
– lower marginal rates at the bottom
• means-testing
i should
h ld b
be lless aggressive
i
• Age-based taxation
– distinguish by age of youngest child
– pre-retirement ages
• Integrate different benefits and tax credits
– improve administration, transparency, take-up, facilitate coherent
design
• Undo distributional effects of the rest of the package…
Indirect Taxation
• Evidence on consumer behaviour => exceptions to uniformity
– Childcare strongly complementary to paid work
– Various work related expenditures (QUAIDS on FES, MRI)
– Human capital
p
expenditures
p
– ‘Vices’: alcohol, tobacco, betting, possibly unhealthy food have
externality / merit good properties Î keep ‘sin taxes’
– Environmental externalities (three separate chapters in MRII)
• These do not line up
p well with existing
g structure of taxes
⇒Broadening the base – many zero rates in UK VAT
• Compensating losers,
losers even on average,
average is difficult
• Worry about work incentives too
• W
Workk with
ith sett off direct
di t tax
t and
d benefit
b
fit instruments
i t
t as in
i earnings
i
tax reforms
Indirect Taxation – UK case
Zero rated:
Zero-rated:
Food
Construction of new dwellings
Domestic passenger transport
I t
International
ti
l passenger transport
t
t
Books, newspapers and magazines
Children’s clothing
ugs a
and
d medicines
ed c es o
on p
prescription
esc pt o
Drugs
Vehicles and other supplies to people with disabilities
Cycle helmets
Reduced-rated:
D
Domestic
ti fuel
f l and
d power
Contraceptives
Children’s car seats
g cessation p
products
Smoking
Residential conversions and renovations
VAT-exempt:
Rent on domestic dwellings
R t on commercial
Rent
i l properties
ti
Private education
Health services
Postal services
Burial and cremation
Finance and insurance
Estimated cost (£m)
11,300
8,200
2,500
150
1,700
1,350
,350
1,350
350
10
2,950
2
950
10
5
10
150
3,500
200
300
900
200
100
4,500
© Institute for Fiscal Studies
Impact on budget share of an additional hour worked
Conditional on income and prices
Bread and Cereals
Negative
Meat and Fish
Negative
g
Dairy products
Negative
Tea and coffee
Negative
Fruit and vegetables
Negative
Food eaten out
Positive
Beer
Positive
Wine and spirits
Positive
Domestic fuels
Negative
Household goods and services
Positive
g
Adult clothing
Positive
Childrens’ clothing
Negative
Petrol and diesel
Positive
Leisure goods and services
Positive
Source: QUAIDS on UK FES, MRI
Compensation package involves:
• A 3.1% increase in all benefits and tax
thresholds.
• A 6.2% increase for the main means-tested
benefits, and for the working tax credit for
non parents.
non-parents.
• An additional 16.9% rise (so giving 20% in
total) in child benefit. This rises from £20 to
£24 a week for the first child, and from £13.20
to £15.80 a week for additional children.
• A further £600 increase in the income tax
allowance for the under 65s, and an increase of
£1,200 for the over 65s. This change has the
effect of taking 1¼ million people out of
income tax.
• A £3,200 cut in the limit for basic rate tax
and the upper earnings
i
limit
i i for National
i
Insurance. This leaves these limits £1,000
below the current nominal level.
Effect of base broadening reform with earnings
t reform
tax
f
compensation,
ti
by
b expenditure
dit
decile
d il
% rise in COL
% rise in inc
cash gain/loss
9%
£10
8%
£8
7%
£6
6%
£4
5%
£2
4%
£0
3%
-£2
2%
-£4
1%
-£6
0%
-£8
Poorest
2
3
4
5
6
7
Expenditure decile group
8
9
Richest
Effect of base broadening reform with earnings tax
instruments as compensation (MRII), by income decile
Reform revenue neutral and designed to leave effective
tax rates on earnings unchanged
40%
45%
50%
55%
5
60%
6
EMTR: before and after indirect tax reform
0
100
200
300
400
500
600
700
800
900
1000 1100 1200
Gross earnings (£/week)
Before reform
After reform
Reform revenue neutral and designed to leave effective
tax rates on earnings unchanged
35%
40%
45%
4
50%
5
55
5%
PTR: before and after indirect tax reform
0
100
200
300
400
500
600
700
800
900
1000 1100 1200
Gross earnings (£/week)
Before reform
After reform
Broadening the base of indirect taxation
• Empirical results suggest current indirect tax rates do not
line up with any reasonable justification and are a poor
way of delivering redistribution given the other tax
instruments available
– Interpretation of results is that we can implement a reform
package
p
g manages
g to achieve compensation
p
while also
avoiding significant damage to work incentives.
– On average the EMTR rise by less than a quarter of a
percentage point and the PTR by less than half a
percentage point.
– little change in work incentives at any earnings level
• Quite sizable welfare gains from removing distortions =>
Welfare gains - Distribution of EV/x by ln(x)
ln x
Source: MRII
The shape of a reform package
• Broaden VAT base
– keep
p childcare differentiation,, sin taxes + reformed
environmental taxes/permits, etc
• Reforms to the income tax / benefit rate schedule
– Apply lessons from empirical evidence on response elasticities
– Compensate
C
t for
f distributional
di t ib ti
l effects
ff t off reform
f
package
k
• Interaction with taxation of corporate profits and the taxation of
saving
Interaction with Corporate Taxation
•
Exempt normal rate to give neutrality between debt and equity
– move toward a source-based
source based ACE system
– recognising that taxing corporate rents on a destination-basis may
be more
o e att
attractive
act e in tthe
e longer
o ge te
term,, pa
particularly
t cu a y if ssignificant
g ca t
revenues from source-based corporate taxes eventually prove to be
unsustainable
•
A progressive rate structure for the shareholder income tax,
((rather than the flat rate proposed
p p
by
y GHS in MRI))
– with progressive tax rates on labour income, progressive rates are
q
on shareholder income to avoid differential tax
also required
treatments of incorporated and unincorporated firms
–
a lower progressive rate structure on shareholder income than on
labour income reflects the corporate tax already paid
Interaction with Corporate Taxation
•
Suitable rate alignment between tax rates on corporate
income, shareholder income and labour income
–
•
deals with many issues in the MRI evidence on small business
taxation
Note current rates on labour income (top 45%) and capital
gains (18%)!
Interaction with the Taxation of
Saving
•
•
Organising principal around which we begun was the
‘expenditure tax’ as in Meade/Bradford but with adaptations
–
coherent approach to taxation of earnings and savings over the
life-cycle – lifetime base
–
provides a framework for the integration of capital income
taxation with corporate taxation
–
capital gains and dividends treated in the same way and
overcomes ‘lock-in’ incentive from CGT
–
can incorporate
p
p
progressivity
g
y and captures
p
excess returns
taxing saving is an inefficient way to redistribute
- assuming that the decision to delay consumption tells us nothing
about ability to earn
•
implies zero taxation of the normal return to capital
–
can be achieved through alternative forms: EET, TEE, TtE(RRA)
Fraction of wealth held in different tax treatments in UK
Decile of
gross
financial
wealth
Range of
gross
financial
wealth
(£’000s)
Proportion of wealth held
in:
Private
ISAs
Other
pensions
assets
Poorest
0 126
0.126
0 091
0.091
0 783
0.783
2
<1.7
<1
7
1.7–16.6
0.548
0.138
0.315
3
16.6–39.1
0.652
0.110
0.238
4
39.1–75.9
0.682
0.108
0.210
5
75.9–122.3
0.697
0.079
0.223
6
122.3–177.2
0.747
0.068
0.185
7
177.2–245.4
0.781
0.062
0.157
8
245 4 350 3
245.4–350.3
0 818
0.818
0 046
0.046
0 136
0.136
9
350.3–511.2
0.790
0.057
0.153
Richest
>511.2
0.684
0.044
0.273
0.736
0.055
Source:All
ELSA, 2004 – at least one member
aged 52-64
0.209
Unfortunately…
Conditions for zero rate on normal return can fail if:
1. Heterogeneity (e.g. high ability people have higher saving rates)
– new evidence and theory, Banks & Diamond (MRI); Laroque, Gordon &
Kopczuk; Diamond & Spinnewijn; …
2 Earnings
2.
E i
risk
i k and
d credit
dit constraints
t i t
– new theory and evidence on earnings ability risk, Golosov, Tsyvinski &
W i
Werning;
Bl
Blundell,
d ll P
Preston
t & Pi
Pistaferri;
t f i C
Conesa, Kit
Kitao & K
Krueger
– e.g. keep wealth low to reduce labour supply response, weaken
incentive compatibility constraint
3. Outside (simple) life-cycle savings models
- myopia; self-control problems; framing effects; information monopolies
4. Non-separability (timing of consumption and labour supply)
5. Evidence suggests a need to adapt standard expenditure tax
arguments
Correct some of the obvious defects:
•
•
•
C
Capture
excess returns and
d rents
–
move to RRA(TtE) or EET where possible – neutrality across assets
–
TEE limited
li it d llargely
l tto iinterest
t
tb
baring
i accounts
t
–
Lifetime accessions tax across generations, if practicable.
P
Pensions
i
- allow
ll
some additional
dditi
l iincentive
ti tto llock-in
k i savings
i
–
twist implicit retirement incentives to later ages
–
current tax free lump sum in UK is too generous and accessed too early
Housing
–
add
dd VAT style
t l property
t tax
t on consumption
ti (rH)
( H)
–
excess returns? Currently TEE in UK – difficult without LVT issues
•
Broaden VAT base
•
Reforms to the income tax / benefit rate schedule
–
Apply lessons from empirical evidence on response elasticities
–
Compensate for other reforms
Empirical Evidence and Tax Policy Design:
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
•
Th importance
The
i
t
off information,
i f
ti
complexity
l it and
d salience
li
•
Evidence on the size of responses
•
Implications for tax design
see
http://www.ifs.org.uk/mirrleesReview
© Institute for Fiscal Studies
But (too) many key issues unresolved, and with little
evidence base (!)
Including:
• Tax credits and earnings progression
• Distinction between dynamic and static policies
• Human capital investment bias and savings taxation
• Taxation of financial services
• Some transition issues and capitalisation
p
• ….
10
00
M
Monthly
earnings
e
200
300
400
SSP: Monthly earnings by months after RA
0
10
20
30
40
Months after random assignment
control
t l
50
60
experimental
i
t l
© Institute for Fiscal Studies
6
Hourly rea
H
al wages
6.5
7
7.5
8
8.5
and dynamic effects on wages and productivity?
0
10
20
30
40
Months after random assignment
control
© Institute for Fiscal Studies
experimental
50
60
Dynamic Effects from the Canadian SSP
• Earnings and employment line up with
control group after time limit is
exhausted
• Littl
Little evidence
id
of
f employment
l
t
enhancement or wage progression
• Other evidence, Taber etc, show some
progression but quite small
• Key area of research
• Some more optimistic results for some
recent UK policies
• What
Wh t about
b t age-based
b
d policies?
p li i ?
© Institute for Fiscal Studies
Some Additional References:
Banks, JJ., Blundell
Banks
Blundell, R
R., and Tanner
Tanner, S
S. (1998) “Is
Is there a retirement
retirement-savings
savings
puzzle?”, American Economic Review, 88, 769 – 788.
Besley, T. and S. Coate (1992), “Workfare
Workfare versus Welfare: Incentive Arguments
for Work Requirement in Poverty Alleviation Programs”, American Economic
Review, 82(1), 249-261.
Blundell, R. (2006), “Earned income tax credit policies: Impact and Optimality”,
The 2005 Adam Smith Lecture, Labour Economics, 13, 423-443.
Blundell, R
Blundell
R.W.,
W Duncan
Duncan, A
A. and Meghir
Meghir, C
C. (1998)
(1998), "Estimating Labour Supply
Responses using Tax Policy Reforms", Econometrica, 66, 827-861.
Blundell, R
Blundell
R, Duncan
Duncan, A
A, McCrae
McCrae, J and Meghir
Meghir, C
C. (2000)
(2000), "The
The Labour Market
Impact of the Working Families' Tax Credit", Fiscal Studies, 21(1).
Blundell, R. and Hoynes, H. (2004), "In-Work Benefit Reform and the Labour
Market", in Richard Blundell, David Card and Richard .B. Freeman (eds)
Seeking a Premier League Economy. Chicago: University of Chicago Press.
Blundell,
Bl
d ll R
R. and
dM
MaCurdy
C d (1999)
(1999), "Labour
"L b
Supply:
S
l A Review
R i
off Alternative
Alt
ti
Approaches", in Ashenfelter and Card (eds), Handbook of Labour Economics,
Elsevier North-Holland.
Blundell, R., Meghir, C., and Smith, S. (2002), ‘Pension incentives and the
pattern of early
p
y retirement’, Economic Journal, 112, C153–70.
Blundell, R., and A. Shephard (2008), ‘Employment, hours of work and the
optimal taxation of low income families’, IFS Working Papers , W08/01
Brewer, M. A. Duncan, A. Shephard, M-J Suárez, (2006), “Did the Working
Families Tax Credit Work?”, Labour Economics, 13(6), 699-720.
Card, David and Philip K. Robins (1998), "Do Financial Incentives Encourage
Welfare Recipients To Work?", Research in Labor Economics, 17, pp 1-56.
Chetty, R
Chetty
R. (2008)
(2008), ‘Sufficient
Sufficient statistics for welfare analysis: a bridge between
structural and reduced-form methods’, National Bureau of Economic Research
(NBER), Working Paper 14399
Diamond, P. (1980): "Income Taxation with Fixed Hours of Work," Journal of
Public Economics, 13, 101-110.
Eissa, Nada and Jeffrey Liebman (1996), "Labor Supply Response to the
Earned Income Tax Credit", Quarterly Journal of Economics, CXI, 605-637.
IImmervoll,
ll H
H. Kl
Kleven, H
H. K
Kreiner,
i
C
C, and
dS
Saez, E
E. (2005)
(2005), `W
Welfare
lf
Reform
R f
in
i
European Countries: A Micro-Simulation Analysis’ Economic Journal.
Keane, M.P. and Moffitt, R. (1998), "A Structural Model of Multiple Welfare
Program
g
Participation
p
and Labor Supply",
pp y International Economic Review,
39(3), 553-589.
Kopczuk, W. (2005), ‘Tax bases, tax rates and the elasticity of reported income’,
J
Journal
l off P
Public
bli E
Economics,
i
89 2093
89,
2093–119.
119
Laroque, G. (2005), “Income Maintenance and Labour Force Participation”,
Econometrica 73(2),
Econometrica,
73(2) 341-376
341-376.
Mirrlees, J.A. (1971), “The Theory of Optimal Income Taxation”, Review of
Economic Studies,, 38,, 175-208.
Moffitt, R. (1983), "An Economic Model of Welfare Stigma", American Economic
Review, 73(5), 1023-1035.
Phelps, E.S. (1994), “Raising the Employment and Pay for the Working Poor”,
American Economic Review, 84 (2), 54-58.
Saez, E. (2002): "Optimal Income Transfer Programs: Intensive versus
Extensive Labor Supply Responses," Quarterly Journal of Economics, 117,
1039-1073.
Sørensen , P. B. (2009) “Dual income taxes: a Nordic tax system”, Paper
prepared for the conference on New Zealand Tax Reform – Where to Next?.
ETRs for basic-rate taxpayer (BRT) and higher-rate taxpayer (HRT)
Asset
Effective tax rate (%)
BRT
HRT
ISA (cash
(
h or stocks
t k and
d shares)
h
)
0
0
Cash deposit account
33
67
E l
Employee
contribution
t ib ti tto pension
i
(i
(invested
t d 10 years))
–21
21
–53
53
(invested 25 years)
–8
–21
(invested 10 years)
–115
–102
(invested 25 years)
–45
–40
0
0
((invested 10 years)
y
)
10
35
(invested 25 years)
7
33
Employer contribution to pension
Owner-occupied housing
Stocks and sharesb
© Institute for Fiscal Studies
Effective tax rates on returns to pension saving
Asset
Effective tax rate (%)
Employee contribution to a pension
Tax rate in work
Tax rate in retirement
Basic rate ((20%))
Basic rate ((20%))
–21
Higher rate (40%)
Higher rate (40%)
–53
Higher rate (40%)
Basic rate (20%)
–122
Basic rate (20%)
Pension credit taper (40%)
Tax credit taper (59%)
Basic rate (20%)
–260
T credit
Tax
dit ttaper (59%)
P
Pension
i credit
dit ttaper (40%)
–189
189
© Institute for Fiscal Studies
46
Interaction with Corporate Taxation
•
A progressive rate structure for the shareholder income tax,
rather than the flat rate p
proposed
p
by
y GHS in MRI
– with progressive tax rates on labour income, progressive rates are
also
a
so required
equ ed o
on sshareholder
a e o de income
co e to
oa
avoid
odd
differential
e e a tax
a
treatments of incorporated and unincorporated firms
–
•
Suitable rate alignment
g
between tax rates on corporate
p
income, shareholder income and labour income
–
•
a lower p
progressive
g
rate structure on shareholder income than on
labour income reflects the corporate tax already paid
deals with many issues in the MRI evidence on small business taxation
Note current rates on labour income (top 45%) and capital
gains (18%)!
© Institute for Fiscal Studies