Econ 551 Government Finance: Revenues Fall, 2019 Given by Kevin - PowerPoint PPT Presentation

Econ 551 Government Finance: Revenues Fall, 2019 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture 5c: Optimal Income Taxation, Part III ECON 551: Lecture 5c 1 of 21

Agenda: 1. Capital income taxation 2. Saez and Stantcheva (2018) 3. Wealth taxation ECON 551: Lecture 5c 2 of 21

Capital Income Taxation:  Through much of the history of though on capital income taxation debate was conceptual: what is income? o Idea of ‘comprehensive’ income: earnings + capital income. o Canadian legal concept of income ‘source’.  Development of optimal income tax starting with Mirrlees (1971) abstracted from capital income.  You can pull out capital taxation implications from early optimal tax papers: o E.g. Diamond- Mirrlees production efficiency: capital is an input so don’t tax it. o E.g. Atkinson- Stiglitz: don’t differentially tax consumption in different periods.  Inherent challenges in modeling: o Dynamics and transition paths, policy uncertainty. ECON 551: Lecture 5c 3 of 21

Does ‘zero capital income taxation’ hold? Judd (1985)  Deterministic dynamic model with infinitely lived agents, workers and capitalists.  Redistribution lowers efficiency.  Steady state has no capital income taxation. Chamley (1986)  Deterministic dynamic model with infinitely lived agent — representative agent.  Steady state has no capital income taxation. Straub and Werning (2020)  Document challenges to the Chamley-Judd result; people questioning the setup/assumptions.  Show that — even within the C-J setup — the result is not robust.  They reduce the key finding to the intertemporal elasticity of savings. > or < 1?  If <1, future capital tax increases lead to more savings now; more investment and growth. ECON 551: Lecture 5c 4 of 21

New Dynamic Public Finance: This literature started with tools of modern ‘Minnesota - style’ macro and addressed the age -old public finance question of capital income taxation in explicitly Mirrleesian models.  Seems like a fruitful direction for literature: they can do dynamics; uncertainty; heterogeneity. Golosov, Tsyvinski, and Kocherlakota (2003) is the starting point.  Positive capital i ncome taxes generated by uncertainty about one’s type. Golosov, Tsyvinski, and Werning (2007) is an early review. Work continues in this area….with varied results on capital income taxes. ECON 551: Lecture 5c 5 of 21

Agenda: 1. Capital income taxation 2. Saez and Stantcheva (2018) 3. Wealth taxation ECON 551: Lecture 5c 6 of 21

A Simpler Model of Optimal Capital Taxation:  Main challenge in the literature: too abstract; doesn’t offer policy relevant predictions or estimable parameters.  Approach: Let’s make some strong assumptions and reduce the proble m to something more solvable.  Applications: Can use their framework to address real-world policy issues like comprehensive vs schedular income taxes; differing ethical views; heterogeneous capital, and more ECON 551: Lecture 5c 7 of 21

The two main assumptions: 1. Wealth in the utility function Motivations  Conceptual: e.g. Smith ‘social status and moral prestige’; Keynes “love of money as a possession.”  Empirical: too much saving for ‘precautionary’ or future consumption for super -wealthy.  Theoretical: bequests, entrepreneurship, direct service flow from wealth, motivated beliefs (self-confidence, moral self-esteem, anxiety reduction). Implications  Keeps things converging and finite in steady-state. 2. Utility linear in consumption Motivation: purely for tractability. This is how they get to ‘simple’. Implications:  Don’t care about smoothing consumption. This is trolling the macro dudes…  Adjustment to changes happens immediately (no need to smooth it out). ECON 551: Lecture 5c 8 of 21

The setup: Instantaneous utility is 𝑣 𝑗 (𝑑,𝑙, 𝑨) = 𝑑 + 𝑏 𝑗 (𝑙) − ℎ 𝑗 (𝑨) :  Consumption is c .  Capital is k ; gives utility according to concave 𝑏 𝑗 (𝑙).  Disutility of earning pretax income z comes from convex ℎ 𝑗 (𝑨) . Individuals are different by their a and h functions. Planne r’s goal: maximize a utilitarian SWF while raising some taxes (returned lumpsum). 𝑇𝑋𝐺 = ∫ 𝜕 𝑗 ∙ 𝑉 𝑗 (𝑑 𝑗 ,𝑙 𝑗 , 𝑨 𝑗 )𝑒𝑗. 𝑗 …where 𝜕 𝑗 is the weight on individual i , with ∫ 𝜕 𝑗 𝑒𝑗 = 1 . 𝑗 The social marginal weight on individual I is denoted by 𝑕 𝑗 = 𝜕 𝑗 ∙ 𝑉 𝑗𝑑 ECON 551: Lecture 5c 9 of 21

Dynamic and simple static problems: The dynamic framework: ∞ 𝑗 ({𝑑 𝑗 (𝑢),𝑙 𝑗 (𝑢), 𝑨 𝑗 (𝑢)} 𝑢≥0 ) = 𝜀 𝑗 ∙ ∫ [𝑑 𝑗 (𝑢) + 𝑏 𝑗 (𝑙 𝑗 (𝑢)) − ℎ 𝑗 (𝑨 𝑗 (𝑢))]𝑓 −𝜀 𝑗 𝑢 𝑒𝑢 𝑊 0 𝑒𝑙 𝑗 (𝑢) = 𝑠𝑙 𝑗 (𝑢) + 𝑨 𝑗 (𝑢) − 𝑈(𝑨 𝑗 (𝑢), 𝑠𝑙 𝑗 (𝑢)) − 𝑑 𝑗 (𝑢) s.t. 𝑒𝑢 Can solve with a Hamiltonian. They show this reduces to a much simpler static problem, given their assumptions: 𝑗𝑜𝑗𝑢 − 𝑙 𝑗 ) 𝑉 𝑗 (𝑑 𝑗 ,𝑙 𝑗 , 𝑨 𝑗 ) = 𝑑 𝑗 + 𝑏 𝑗 (𝑙 𝑗 ) − ℎ 𝑗 (𝑨 𝑗 ) + 𝜀 𝑗 ∙ (𝑙 𝑗 s.t. 𝑑 𝑗 = 𝑠𝑙 𝑗 + 𝑨 𝑗 − 𝑈(𝑨 𝑗 , 𝑠𝑙 𝑗 ) This is much more tractable and can be used for policy analysis. ECON 551: Lecture 5c 10 of 21

Lemmata Corner: Define welfare weights: ∫ 𝑕 𝑗 ∙ 𝑙 𝑗 ∫ 𝑕 𝑗 ∙ 𝑨 𝑗 𝑕̅ 𝐿 = 𝑗 𝑕̅ 𝑀 = 𝑗 and ∫ 𝑙 𝑗 ∫ 𝑨 𝑗 𝑗 𝑗 …this is zero when I don’t care about anyone with capital; one when everyone gets the same welfare weight. Define elasticities: 𝑒𝑙 𝑛 𝑒𝑨 𝑛 𝑠∙(1−𝜐 𝐿 ) (1−𝜐 𝑀 ) 𝑓 𝐿 = ∙ 𝑓 𝑀 = ∙ 𝑒𝑠∙(1−𝜐 𝐿 ) and 𝑒(1−𝜐 𝑀 ) 𝑙 𝑛 𝑨 𝑛 ECON 551: Lecture 5c 11 of 21

Optimal tax formulae: 1 − 𝑕̅ 𝐿 𝜐 𝐿 = 1 − 𝑕̅ 𝐿 + 𝑓 𝐿 1 − 𝑕̅ 𝑀 𝜐 𝑀 = 1 − 𝑕̅ 𝑀 + 𝑓 𝑀  These are of familiar form.  Can be ea sily extended to nonlinear… ECON 551: Lecture 5c 12 of 21

Optimal tax rates for Labour and Capital: ECON 551: Lecture 5c 13 of 21

Policy applications: 1. Fairness: 𝜐 𝐿 = 0 if people don’t care about inequality of wealth; 𝜐 𝐿 > 0 otherwise. 2. Growth: upper bound is 𝜐 𝐿 = 1 − 𝑕 𝑠 ⁄ . 3. Jointness in preferences for labour and capital. Can handle it with cross-elasticities. 4. Comprehensive income tax system 𝑈(𝑨 + 𝑠𝑙) : 1 − 𝑕̅ 𝑍 𝜐 𝑍 = 1 − 𝑕̅ 𝑍 + 𝑓 𝑍  Just has weighted averages of the labour and capital components. 5. Income shifting between bases: This can justify comprehensive base, as shifting goes to infinity. 6. Consumption tax: equivalent to labour tax + tax on initial wealth. Standard result. 7. Heterogeneous returns to wealth: doesn’t affect optimal formulae; might affect Fairness sentiments. 𝑘 and 𝑓 𝐿 𝑘 . 8. Different types of capital j : tax rate set depending on 𝑕̅ 𝐿 ECON 551: Lecture 5c 14 of 21

Summary:  If you buy the linear consumption and wealth-in-utility assumptions, you can really simplify the structure of the problem.  Delivers clear decision rules about labour, capital, or comprehensive income taxation.  Are those assumptions reasonable? Are the results sufficiently interesting to justify these strong assumptions? ECON 551: Lecture 5c 15 of 21

Agenda: 1. Capital income taxation 2. Saez and Stantcheva (2018) 3. Wealth taxation ECON 551: Lecture 5c 16 of 21

Wealth taxation: This was a long-neglected corner of public finance…. until…. ECON 551: Lecture 5c 17 of 21

Wealth taxation: Senator Elizabeth Warren Presidential candidate Senator Elizabeth Warren proposed a 2% annual wealth tax on wealth over $50 million. Senator Bernie Sanders now has a proposal too. Now in Canada, the federal NDP has proposed a 1% wealth tax. So, wealth taxes are back on the policy agenda. Academics are now trying to catch up … . ECON 551: Lecture 5c 18 of 21

What is a wealth tax? What is the base? Can we measure these things? Is it annual? At death/estate/inheritance? Wealth transfer? Net or gross? Why would you want to tax wealth? Why not? Survey and review: Boadway, Chamberlain, Emmerson (2010 Mirrlees Review). Recent Canadian policy paper: Boadway and Pestieau (2019 CD Howe). ECON 551: Lecture 5c 19 of 21

Wealth taxes vs. other tax tools Boadway and Pestieau (2018):  Think of wealth as a flat tax on capital income.  Could replace an annual wealth tax with regular capital income taxation + estate tax.  Anything tip the balance one way or the other? o Administrative / measurement issues. o Avoidability. o Taxation of windfall gains. ECON 551: Lecture 5c 20 of 21

Wealth tax: Administrative issues See recent OECD (2018) review of wealth taxation.  Substantial scope for avoidance. o Games with debt. o ‘ Small business ’ capital. o Excluded assets (e.g. art).  Valuation issues. o Stamp collections!  Evasion. o Tax havens exist.  Liquidity. o Asset rich / income poor people may suffer. ECON 551: Lecture 5c 21 of 21