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

ECON 551: Lecture 5c 1 of 21

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 2 of 21

Agenda:

• 1. Capital income taxation
• 2. Saez and Stantcheva (2018)
• 3. Wealth taxation

ECON 551: Lecture 5c 3 of 21

Capital Income Taxation:

 Through much of the history of though on capital income taxation debate was conceptual: what is income?

• Idea of ‘comprehensive’ income: earnings + capital income.
• 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:

• E.g. Diamond-Mirrlees production efficiency: capital is an input so don’t tax it.
• E.g. Atkinson-Stiglitz: don’t differentially tax consumption in different periods.

 Inherent challenges in modeling:

• Dynamics and transition paths, policy uncertainty.

ECON 551: Lecture 5c 4 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 5 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 income 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 6 of 21

Agenda:

• 1. Capital income taxation
• 2. Saez and Stantcheva (2018)
• 3. Wealth taxation

ECON 551: Lecture 5c 7 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 problem 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 8 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 9 of 21

The setup:

Instantaneous utility is 𝑣𝑗(𝑑,𝑙, 𝑨) = 𝑑 + 𝑏𝑗(𝑙) − ℎ𝑗(𝑨):  Consumption is c.  Capital is k; gives utility according to concave 𝑏𝑗(𝑙).  Disutility of earning pretax income z comes from convex ℎ𝑗(𝑨). Individuals are different by their a and h functions. Planner’s goal: maximize a utilitarian SWF while raising some taxes (returned lumpsum). 𝑇𝑋𝐺 = ∫ 𝜕𝑗 ∙ 𝑉𝑗(𝑑𝑗,𝑙𝑗, 𝑨𝑗)𝑒𝑗.

𝑗

…where 𝜕𝑗 is the weight on individual i, with ∫ 𝜕𝑗

𝑗

𝑒𝑗 = 1. The social marginal weight on individual I is denoted by 𝑕𝑗 = 𝜕𝑗 ∙ 𝑉𝑗𝑑

ECON 551: Lecture 5c 10 of 21

Dynamic and simple static problems:

The dynamic framework: 𝑊

𝑗({𝑑𝑗(𝑢),𝑙𝑗(𝑢), 𝑨𝑗(𝑢)}𝑢≥0) = 𝜀𝑗 ∙ ∫ [𝑑𝑗(𝑢) + 𝑏𝑗(𝑙𝑗(𝑢)) − ℎ𝑗(𝑨𝑗(𝑢))]𝑓−𝜀𝑗𝑢𝑒𝑢 ∞

s.t.

𝑒𝑙𝑗(𝑢) 𝑒𝑢

= 𝑠𝑙𝑗(𝑢) + 𝑨𝑗(𝑢) − 𝑈(𝑨𝑗(𝑢), 𝑠𝑙𝑗(𝑢)) − 𝑑𝑗(𝑢) Can solve with a Hamiltonian. They show this reduces to a much simpler static problem, given their assumptions: 𝑉𝑗(𝑑𝑗,𝑙𝑗, 𝑨𝑗) = 𝑑𝑗 + 𝑏𝑗(𝑙𝑗) − ℎ𝑗(𝑨𝑗) + 𝜀𝑗 ∙ (𝑙𝑗

𝑗𝑜𝑗𝑢 − 𝑙𝑗)

s.t. 𝑑𝑗 = 𝑠𝑙𝑗 + 𝑨𝑗 − 𝑈(𝑨𝑗, 𝑠𝑙𝑗) This is much more tractable and can be used for policy analysis.

ECON 551: Lecture 5c 11 of 21

Lemmata Corner:

Define welfare weights: 𝑕̅𝐿 =

∫ 𝑕𝑗∙

𝑗

𝑙𝑗 ∫ 𝑙𝑗

𝑗

and 𝑕̅𝑀 =

∫ 𝑕𝑗∙

𝑗

𝑨𝑗 ∫ 𝑨𝑗

𝑗

…this is zero when I don’t care about anyone with capital; one when everyone gets the same welfare weight. Define elasticities: 𝑓𝐿 =

𝑠∙(1−𝜐𝐿) 𝑙𝑛

∙

𝑒𝑙𝑛 𝑒𝑠∙(1−𝜐𝐿)

and 𝑓𝑀 =

(1−𝜐𝑀) 𝑨𝑛

∙

𝑒𝑨𝑛 𝑒(1−𝜐𝑀)

ECON 551: Lecture 5c 12 of 21

Optimal tax formulae:

𝜐𝐿 = 1 − 𝑕̅𝐿 1 − 𝑕̅𝐿 + 𝑓𝐿 𝜐𝑀 = 1 − 𝑕̅𝑀 1 − 𝑕̅𝑀 + 𝑓𝑀  These are of familiar form.  Can be easily extended to nonlinear…

ECON 551: Lecture 5c 13 of 21

Optimal tax rates for Labour and Capital:

ECON 551: Lecture 5c 14 of 21

Policy applications:

• 1. Fairness: 𝜐𝐿 = 0 if people don’t care about inequality of wealth; 𝜐𝐿 > 0 otherwise.
• 2. Growth: upper bound is 𝜐𝐿 = 1 − 𝑕 𝑠

⁄ .

• 3. Jointness in preferences for labour and capital. Can handle it with cross-elasticities.
• 4. Comprehensive income tax system 𝑈(𝑨 + 𝑠𝑙):

𝜐𝑍 = 1 − 𝑕̅𝑍 1 − 𝑕̅𝑍 + 𝑓𝑍  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.

• 8. Different types of capital j: tax rate set depending on 𝑕̅𝐿

𝑘 and 𝑓𝐿 𝑘.

ECON 551: Lecture 5c 15 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 16 of 21

Agenda:

• 1. Capital income taxation
• 2. Saez and Stantcheva (2018)
• 3. Wealth taxation

ECON 551: Lecture 5c 17 of 21

Wealth taxation:

This was a long-neglected corner of public finance…. until….

ECON 551: Lecture 5c 18 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 19 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 20 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?

• Administrative / measurement issues.
• Avoidability.
• Taxation of windfall gains.

ECON 551: Lecture 5c 21 of 21

Wealth tax: Administrative issues

See recent OECD (2018) review of wealth taxation.  Substantial scope for avoidance.

• Games with debt.
• ‘Small business’ capital.
• Excluded assets (e.g. art).

 Valuation issues.

• Stamp collections!

 Evasion.

• Tax havens exist.

 Liquidity.

• Asset rich / income poor people may suffer.