Empirical Evidence and Tax Policy Design: Lessons …uctp39a/CEA June 2010 Blundell...

Empirical Evidence and Tax Policy Design: Lessons from the Mirrlees Review

44th Annual Conference of the CEAMay 2010

Richard BlundellUniversity College London and Institute for Fiscal Studiesy g

© 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• Then a discussion on the role of evidence loosely organised under five headings:

1 Key margins of adjustment to tax reform1. Key margins of adjustment to tax reform

2. Measurement of effective tax rates

3. The importance of information, complexity and salience

4. Evidence on the size of responsesp

5. Implications for tax design

• Focus on earnings tax and indirect tax design as• Focus on earnings tax and indirect tax design as leading examples

The Mirrlees ReviewReforming the Tax System for the 21st CenturyReforming the Tax System for the 21st Century

Editorial TeamCh i Si J Mi lChairman: Sir James Mirrlees

Tim Besley (LSE & IFS)Richard Blundell (UCL & IFS)Richard Blundell (UCL & IFS)

Malcolm Gammie QC (One Essex Court & IFS)James Poterba (MIT & NBER)

Stuart Adam (IFS)Steve Bond (Oxford & IFS)

Robert Chote (IFS)Robert Chote (IFS)Paul Johnson (IFS & Frontier)Gareth Myles (Exeter & IFS)y ( )

The Mirrlees Review• Review of tax design from first principles

– For modern open economies in general and UK in particular – Reflect changes in the world, changes in our understanding

and increased empirical knowledge

• Two volumes:- ‘Dimensions of Tax Design’: a set of 13 chapters on particular g p p

areas co-authored by international experts and IFS researchers, along with expert commentaries (MRI)

- ‘Tax by Design’: an integrated picture of tax design and reform, written by the editors (MRII)h // if k/ i l R i / bli i– http://www.ifs.org.uk/mirrleesReview/publications

• MRI on the web and at OUP.

Dimensions of Tax Design: commissioned chapters and expert commentaries (1)

• The base for direct taxationJames Banks and Peter Diamond; Commentators: Robert Hall; John Kay; Pierre Pestieau

• Means testing and tax rates on earningsMike Brewer, Emmanuel Saez and Andrew Shephard; Commentators: Hilary Hoynes; Guy Laroque; Robert Moffitt

• Value added tax and excisesIan Crawford, Michael Keen and Stephen Smith; Commentators: Richard Bird; Ian Dickson/David White; Jon Gruber

• Environmental taxationDon Fullerton, Andrew Leicester and Stephen Smith; Commentators: Lawrence Goulder; Agnar SandmoLawrence Goulder; Agnar Sandmo

• Taxation of wealth and wealth transfersRobin Boadway, Emma Chamberlain and Carl Emmerson; Commentators: Helmuth Cremer; Thomas Piketty; Martin WealeCommentators: Helmuth Cremer; Thomas Piketty; Martin Weale

Dimensions of Tax Design: commissioned chapters and expert commentaries (2)

• International capital taxationRachel Griffith, James Hines and Peter Birch Sørensen; Commentators: Julian Alworth; Roger Gordon and Jerry Hausman; g y

• Taxing corporate income Alan Auerbach, Mike Devereux and Helen Simpson; Commentators: Harry Huizinga; Jack MintzHarry Huizinga; Jack Mintz

• Taxation of small businessesClaire Crawford and Judith Freedman

• The effect of taxes on consumption and savingOrazio Attanasio and Matthew Wakefield

• Administration and compliance Jonathan Shaw Joel Slemrod and JohnAdministration 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 LukePolitical economy of tax reform, James Alt, Ian Preston and Luke Sibieta; Commentator: Guido Tabellini

labour supply responses for individuals and families

Increased empirical knowledge: – some examples• labour supply responses for individuals and families

– at the intensive and extensive margins– by age and demographic structurey g g p

• taxable income elasticities– top of the income distribution using tax return information

• consumer responses to indirect taxation– importance (or not) of nonseparability and variation in price

elasticities• intertemporal 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• ability to (micro-)simulate marginal and average rates

– simulate ‘optimal’ reforms

Empirical Evidence and Tax Policy Design• Here I will focus on earnings taxation and indirect

taxation:

• Leading examples of the mix of theory and evidence

K i li ti f t d i• Key implications for tax design

• Earnings taxation, in particular, takes most of the strain in distributional adjustments of other parts of the reform packagep g

E t i d i t i i f l b l

Key Margins of Adjustment

• Extensive and intensive margins of labour supply

• Its not all the extensive margin

– Intensive and extensive margins both matter

– They matter for tax policy evaluation and design

– And they matter in different ways by age and y y y gdemographic groups

G tti it i ht f• Getting it right for men

Employment for men by age – FR, UK and US 2007

90%

100%

FRUK

60%

70%

80% UKUS

40%

50%

60%

20%

30%

40%

0%

10%

20%

161820 222426 283032 343638 404244 464850 525456 586062 646668 707274

Blundell, Bozio and Laroque (2010)

Total Hours for men by age – FR, UK and US 2007

2000FR

UK

1500

1750US

1000

1250

500

750

0

250

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


Total Hours for men by age in the UK: 1977 - 20072250

2000

2250

20071977

1500

1750 197719871997

1000

1250

500

750

0

250

6 9 2 5 8 1 4 7 0 3 6 9 2 5 8 1 4 7 0 316 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73


E t i d t i i f

Key Margins of Adjustment

• Extensive and extensive margins for women

Female Employment by age – US, FR and UK 1977

0.80

0.90

FR

UK

0.60

0.70 US

0.40

0.50

0.20

0.30

0 00

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 66 68 70 72 74


Female Employment by age – US, FR and UK 20070.90

0.80FR

UK

0.60

0.70 US

0.40

0.50

0.20

0.30

0.10

0.20

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 66 68 70 72 74


Female Hours by age – US, FR and UK 20071600

1400

1600

FR

UK

1000

1200US

800

400

600

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


Female Hours by age – US, FR and UK 19771600

1400

1600

FR

UK

1000

1200US

800

400

600

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


The extensive – intensive distinction is important for a number of reasonsfor a number of reasons

• Understanding responses to tax and welfare reformH k R Wi ll hi hli ht th– Heckman, Rogerson, Wise, .. all highlight the importance of extensive labour supply margin Blundell Bozio and Laroque (2010)– Blundell, Bozio and Laroque (2010)

• The extensive and intensive elasticities are also key parameters in the recent literature on tax design usedparameters in the recent literature on tax design – used heavily in the Mirrlees Review.

• But these elasticities have changed over time and the• But these elasticities have changed over time and the relative importance of the extensive margin is specific to particular groups

• I’ll examine a specific example in more detail in what follows

Why is this distinction important for tax design?Some key lessons from recent tax design theory (Saez• Some key lessons from recent tax design theory (Saez, Laroque, ..)

• A ‘large’ extensive elasticity at low earnings can ‘turn g y garound’ the impact of declining social weights– implying a higher transfer to low earning workers than

those out of workthose out of work– a role for earned income tax credits

• But how do individuals perceive the tax rates on earnings• 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?• Importance of margins other than labour supply/hours

U f t bl i l ti iti t id h i f t• Use of taxable income elasticities to guide choice of top tax rates

• The first step (impact) is a positive analysis of household

An Analysis in Two Steps

• The first step (impact) is a positive analysis of household decisions. There are two dominant empirical approaches to the measurement of the impact of tax reform – both prove useful:

• 1. A ‘quasi-experimental’ evaluation of the impact of q p phistoric reforms /and randomised experiments

• 2. A ‘structural’ estimation based on a general discrete choice model with (unobserved) heterogeneity

• The second step (optimality) is the normative analysis or ti l li l ioptimal policy analysis

– Examines how to best design benefits, in-work tax credits and earnings tax rates with (un)observedcredits and earnings tax rates with (un)observed heterogeneity and unobserved earnings ‘capacity’

Alternative approaches to measuring the impact:St t l d l• Structural model– Simulate effect of actual or hypothetical reforms– Useful for optimal design too, but, robust?

• Quasi-experiment/Difference-in-differences– Compares outcomes of eligibles and non-eligibles and

estimates ‘average’ impact of past reform– Only indirectly related to what is needed for optimal

design

• Randomised experiment? SSP?

Focus here on 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 are well over 80% for some lowMarginal tax rates are well over 80% for some low income working families because of phasing-out of means-tested benefits and tax creditsmeans tested benefits and tax credits

– Working Families Tax Credit + Housing Benefit in UK

– and interactions with the income tax system

– for example, we can examine a typical budget p , yp gconstraint for a single mother…

The interaction of WFTC with other benefits in the UK

£300Low wage lone parent

£200

£250

Local tax rebate

£150

£200 Rent rebateWFTCIncome Support

£50

£100 Net earningsOther income

St£0

£50

0 4 8 2 6 0 4 8 2 6 0 4 8

Strong implications for EMTRs,0 4 8 12 16 20 24 28 32 36 40 44 48

hours of work

for EMTRs, PTRs and labour supply

Average EMTRs across the earnings distribution for different family types y yp

80%

0%70

%50

%60

40%

0 100 200 300 400 500 600 700 800 900 1000 1100 12000 100 200 300 400 500 600 700 800 900 1000 1100 1200Employer cost (£/week)

Single, no children Lone parent

Mirrlees Review (2010)

g , pPartner not working, no children Partner not working, childrenPartner working, no children Partner working, children

Can the reforms explain weekly hours worked?Single Women (aged 18 45) 2002Single Women (aged 18-45) - 2002

Blundell and Shephard (2010)

Hours’ distribution for lone parents, before


Hours’ distribution for lone parents, after


WFTC Reform: Quasi-experimental Evaluation Matched Difference-in-Differences

Single Mothers Marginal Standard Sample Size

Average Impact on % Employment Rate of Single Mothers

g gEffect Error

p

Family Resources

3.5 1.55 25,163Resources SurveyLabour Force 3.6 0.55 233,208Survey

,

Data: FRS, 45,000 adults per year, Spring 1996 – Spring 2002., , p y , p g p g

Base employment level: 45% in Spring 1997.

Matching Covariates: age, education, region, ethnicity,..

But quasi-experimental evidence is rarely enough for tax design

Key features of the structural model

Preferences ( , ; , )hU c h X εtypically approximated by shape constrained sieves

S l d l l ll f

( , ; , )h

• Structural model also allows for

- unobserved work-related fixed costs

- childcare costs

- observed and unobserved heterogeneity

- programme participation ‘take-up’ costsprogramme participation take up costs

Importance of take-up and information/hassle costsVariation in take-up probability with entitlement to FC/WFTC

1.8

e-up

4.6

ility

of t

ake

.2.4

Prob

ab0

0 50 100 150 200FC/WFTC entitlement (£/week, 2002 prices)


( p )

Lone parents Couples

Key features of the structural model

• budget constraint – tax/tax-credit and benefit interactions

main elements:

budget constraint tax/tax-credit and benefit interactions

• heterogeneity – demographics, ethnicity, etc; unobs. het.

• fixed costs of work – obs. and unobs. het.

• stigma/hassle costs take up versus eligibility; unobs het• stigma/hassle costs – take-up versus eligibility; unobs het.

• childcare costs

- mixed-multinomial specification across discrete choices over ranges of hours.

What about the size of labour supply responses?Structural Model Elasticities – low education lone parentsp

(b) Youngest Child Aged 4-11

WeeklyEarnings

Density Extensive Intensive

0 0 43270 0.4327

50 0.1575 0.380 (.020) 0.085 (.009) 150 0 1655 0 321 ( 009) 0 219 ( 025)150 0.1655 0.321 (.009) 0.219 (.025)250 0.1298 0.172 (.005) 0.194 (.020)350 0.028 0.068 (.003) 0.102 (.010)( ) ( )Employment elasticity 0.820 (.042)


Structural Model Elasticities – low education lone parents

Weekly Density Extensive Intensive

(b) Youngest Child Aged 11-18

Weekly Earnings


0 0.3966

50 0.1240 0.144 (.018) 0.130 (.016)150 0.1453 0.153 (.008) 0.387 (.042)250 0.1723 0.097 (.004) 0.340 (.035)350 0.1618 0.045 (.002) 0.170 (.015)E l t l ti it 0 601 ( 036)Employment elasticity 0.601 (.036)


(c) Youngest Child Aged 0 3

Structural Model Elasticities – low education lone parents

Weekly Earnings


(c) Youngest Child Aged 0-3

Earnings0 0.5942

50 0 1694 0 168 ( 017) 0 025 ( 003)50 0.1694 0.168 (.017) 0.025 (.003)150 0.0984 0.128 (.012) 0.077 (.012)250 0.0767 0.043 (.004) 0.066 (.010)( ) ( )350 0.0613 0.016 (.002) 0.035 (.005)Participation elasticity 0.536 (.047)

• Differences in intensive and extensive margins by age and demographics have strong implications for the design of the tax schedule... Non-monotonic in age of youngest child

But do we believe the structural model estimates?

Structural Simulation of the WFTC Reform:

WFTC Tax Credit Reform

All y child y child y child y childAll y-child y-child y-child y-child0 to 2 3 to 4 5 to 10 11 to 18

Change in employment rate: 5 95 3 09 7 56 7 54 4 96Change in employment rate: 5.95 3.09 7.56 7.54 4.960.74 0.59 0.91 0.85 0.68

Average change in hours: 1.79 0.71 2.09 2.35 1.65Average change in hours: 1.79 0.71 2.09 2.35 1.650.2 0.14 0.23 0.34 0.2

N t Si l t d FRS d t St d d i it li

– relatively ‘large’ impact

Notes: Simulated on FRS data; Standard errors in italics.


Impact of WFTC reform on lone parent, 2 children

£300

£250

ncom

e 1999 2002

£150

£200

kly

net i

£100

£150

Wee

0 4 8 12 16 20 24 28 32 36 40 44 48

Hours/week• Notes: Two children under 5. Assumes hourly wage of £4.10, no housing costs or council tax

liability and no childcare costs.

Impact of WFTC and IS reforms on lone parent, 2 children

£300

£250

inco

me 1999 2002

£150

£200

ekly

net

i

£100

£150

Wee

0 4 8 12 16 20 24 28 32 36 40 44 48

Hours/week• Notes: Two children under 5 Assumes hourly wage of £4 10 no housing costs or council tax• Notes: Two children under 5. Assumes hourly wage of £4.10, no housing costs or council tax

liability and no childcare costs.

Structural Simulation of the WFTC Reform:

Impact of all Reforms

All y child y child y child y childAll y-child y-child y-child y-child0 to 2 3 to 4 5 to 10 11 to 18

Change in employment rate: 3 68 0 65 4 53 4 83 4 03Change in employment rate: 3.68 0.65 4.53 4.83 4.030.84 0.6 0.99 0.94 0.71

Average change in hours: 1.02 0.01 1.15 1.41 1.24e age c a ge ou s 0 0 0 50.23 0.21 0.28 0.28 0.22

h th i t f tti th ff ti t t i ht• shows the importance of getting the effective tax rates right especially when comparing with quasi-experiments.• Compare with experiment or quasi-experiment.Compare with experiment or quasi experiment.

Evaluation of the ‘ex-ante’ structural model

• The diff-in-diff impact parameter can be identified from the structural evaluation model

• Simulated diff-in-diff parameter• The structural model then defines the average impact of the g p

policy on the treated as:

( ) Pr[ 0 | , 1] Pr[ 0 , 0]SEM X h X D h X Dα = > = − > =

• Compare simulated diff-in-diff moment with diff-in-diff ( ) [ 0 | , ] [ 0 , 0]SEM h hα

1 1 1 0DD T t T t∫ ∫ ∫ ∫ ∫1, 1 1, 0

0 1 0 0

( , , 1) ( , , 0)DD T t T tSEM X X

X X X

T T

f X D dF dF f X D dF dFε εε ε

α ε ε= = = == = − =

⎡ ⎤

∫ ∫ ∫ ∫ ∫

∫ ∫ ∫0, 1 0, 0( , , 0) ( , , 0)T t T tX X

X

f X D dF dF f X D dF dFε εε ε

ε ε= = = =⎡ ⎤− = − =⎢ ⎥⎣ ⎦∫ ∫ ∫

Evaluation of the ex-ante model

• The simulated diff-in-diff parameter from the structural evaluation model is precise and does not differ i ifi tl f th diff i diff ti t [ 3 6 ( 55) ]significantly from the diff-in-diff estimate [ 3.6 (.55) ]

• Compare simulated diff-in-diff moment with diff-in-diff – .29 (.73), chi-square p-value .57

• Consider additional moments– education: low education: 0.33 (.41)

youngest child interaction– youngest child interaction • Youngest child aged < 5: .59 (. 51)• Youngest child aged 5-10: .31 (.35)

Structural Model Comparisons

© Institute for Fiscal Studies Blundell and Shephard (2010)

• Assume earnings (and certain characteristics) are all that isA optimal tax design framework• Assume earnings (and certain characteristics) are all that is

observable to the tax authorityrelax below to allow for ‘partial’ observability of hours– relax below to allow for partial observability of hours

∫ ∫Social welfare, for individuals of type X

* * *

,

( ( ( , ; ), ; , )) ( ) ( ; )w X

W U wh T w h X h X dF dG w Xε

ε ε= Γ −∑ ∫ ∫The tax structure T(.) is chosen to maximise W, subject

to:* *( ; ) ( ) ( ; ) ( )T wh h X dF dG w X T Rε∑ ∫ ∫

,

( , ; ) ( ) ( ; ) ( )w X

T wh h X dF dG w X T Rε

ε = = −∑ ∫ ∫for a given R.

Control preference for equality by transformation function:p q y y

{ }1( | ) (exp ) 1U U θθΓ = −{ }( | ) ( p )θ

when θ is negative, the function favors the equality of ili iutilities.

Define u(j) = u(cj , hj ;X,ε). If θ < 0 then the integral over (Type I extreme-value) state specific errors is given by:

1 (1 ) (exp ( )) 1u j θθθ⎡ ⎤Γ − ⋅ −⎣ ⎦θ ⎣ ⎦

Implied Optimal Schedule, Youngest Child Aged 0-3

350.00

250.00

300.00

200.00

100.00

150.00

0 50 100 150 200 250 300

No hours rule Weekly earningsMarch 2002 pricesp



350.00

250.00

300.00

200.00

100 00

150.00

100.000 50 100 150 200 250 300

No hours rule 16 hours ruleWeekly earningsMarch 2002 pricesp



350.00

250.00

300.00

200.00

150.00

100.000 50 100 150 200 250 300

No hours ruleWeekly earningsMarch 2002 pricesMarch 2002 prices



350.00

250.00

300.00

200.00

150.00

100.000 50 100 150 200 250 300

No hours rule 16 hours ruleWeekly earningsMarch 2002 pricesMarch 2002 prices



350.00

250.00

300.00

200.00

250.00

150.00

100.000 50 100 150 200 250 300

No hours rule 16 hours rule



350.00

250 00

300.00

200.00

250.00

150.00

100.000 50 100 150 200 250 300

ONo hours rule Optimal hours rule


Implications for Tax ReformCh t f /t t t t t t h l f• Change transfer/tax rate structure to match lessons from ‘new’ optimal tax analysis and empirical evidence:

• Lower marginal rates at the bottom• Lower marginal rates at the bottom• means-testing should be less aggressive

t l t f k• at least for some key groups =>• Age-based taxation

– distinguish by age of youngest child for mothers/parents

– pre-retirement ages• Hours rules? – at full time for older kids,

– welfare gains depend on ability of tax authority to monitor hours

• Impact of reforms on PTRs and EMTRs (MRII) →

Effect of child age revenue neutral reforms on average PTRs across the earnings distribution, by age of youngest child

%60

%0%

50%

30%

4020

%3

Notes: Non-par

0 100 200 300 400 500 600 700 800 900 1000 1100 1200Gross earnings (£/week)

Youngest child 0-3, before reform Youngest child 0-3, after reformYoungest child 4-11, before reform Youngest child 4-11, after reform

Effect of child age revenue neutral reforms on average EMTRs across the earnings distribution, by age of youngest child

%70

%0%

60%

40%

5030

%4

0 100 200 300 400 500 600 700 800 900 1000 1100 1200

Gross earnings (£/week)

Y t hild 0 3 b f f Y t hild 0 3 ft f


Youngest child 0-3, before reform Youngest child 0-3, after reform

Youngest child 4-11, before reform Youngest child 4-11, after reform

Effect of early retirement revenue neutral reforms on average PTRs across the earnings distribution, by age

%60

%%

50%

5540

%45

%30

%35

%3

0 100 200 300 400 500 600 700 800 900 1000 1100 1200Employer cost (£/week)

U d 55 b f f U d 55 ft fUnder 55, before reform Under 55, after reform55-70, before reform 55-70, after reform

Effect of early retirement revenue neutral reforms on average EMTRs across the earnings distribution, by age

60%

%50

%0%

40%

20%

302


Under 55, before reform Under 55, after reform55-70, before reform 55-70, after reform

Reforming Tax Rates• Change transfer/tax rate structure to match lessons from ‘new g

‘microeconometric’ optimal tax’ analysis• lower marginal rates at the bottom

– means-testing should be less aggressive– distinguish by age of youngest child

• The child-age tax reforms redistribute to families with younger children and involve a relatively large increase employment and aggregate earningsand aggregate earnings

• Age-based taxation– pre-retirement agespre retirement ages– important employment increases from age-based reforms

• Undo distributional effects of the rest of the packageUndo distributional effects of the rest of the package…• For example, base broadening in the structure of VAT

Broadening the Base: Indirect Taxation• Evidence on consumer behaviour => exceptions to uniformity• Evidence on consumer behaviour => exceptions to uniformity

– Childcare strongly complementary to paid work– Various other work/time related expenditures– Various other work/time related expenditures

• conditional QUAIDS on FES, MRI

– ‘Vices’: alcohol, tobacco, betting; also environmental externalities g(three separate chapters in MRII)

• These do not line up well with existing structure of taxes⇒Broadening the base – many zero rates in UK VAT

• Compensating losers, even on average, is difficult• Especially when we worry about work incentives too• Work with new set of direct tax and benefit instruments as in

earnings tax reformsearnings tax reforms

Zero-rated:F d

Cost (£m)11 300

Indirect Taxation – UK case

FoodConstruction of new dwellingsDomestic passenger transportInternational passenger transport

11,3008,2002,500150International passenger transport

Books, newspapers and magazinesChildren’s clothingDrugs and medicines on prescription

1501,7001,3501,350Drugs and medicines on prescription

Vehicles and other supplies to people with disabilitiesReduced-rated:

Domestic fuel and power

1,350350

2,950pResidential conversions and renovations

VAT-exempt:Rent on domestic dwellings

,150

3,500Rent on commercial propertiesFinance and insurance

2004,500


Impact on budget share of an additional hour workedConditional on income and prices

Bread and Cereals Negative

Meat and Fish Negative

Dairy products NegativeDairy products Negative

Tea and coffee Negative

Fruit and vegetables Negative

Food eaten out Positive

Beer Positive

Wine and spirits PositiveWine and spirits Positive

Domestic fuels Negative

Household goods and services Positive

Adult clothing Positive

Childrens’ clothing Negative

Petrol and diesel PositivePetrol and diesel Positive

Leisure goods and services Positive

Source: QUAIDS on UK FES, MRI

Compensation and work incentives

• Changes in benefits, tax credits and tax rates and thresholds.

• Relatively easy to compensate for income losses but no so easy to do so in a way that minimises labour supply distortions

• Incorporate child age and age-based reforms

Effect of base broadening reform with earnings tax instruments as compensation (MRII), by income decile

9%

% rise in COL % rise in inc

7%

8%

4%

5%

6%

2%

3%

4%

0%

1%

Poorest 2 3 4 5 6 7 8 9 Richest

Income decile group

Reform revenue neutral and designed to leave effective tax rates on earnings unchanged EMTR: before and after indirect tax reformEMTR: before and after indirect tax reform

60%

55%

%50

%40

%45

%4


Before reform After reform

Reform revenue neutral and designed to leave effective tax rates on earnings unchangedPTR: before and after indirect tax reform

55%

PTR: before and after indirect tax reform50

%%

45%

5%40

%35


Before reform After reform

Welfare gains - Distribution of EV/x by ln(x)

Source: MRII

ln x

S i i h i tf li i

(Some other) Key Margins of Adjustment• Savings-pension-housing portfolio mix

– ‘Life-cycle’ accumulation of savings and pension contributions

– Expenditure tax treatment with certain ‘behavioural’ deviations and capturing all excess returns

• Forms of remuneration

– CGT reforms and the non-alignment with labour income rates

– Related to tax base and top tax rates

• Organisational form• Organisational form

– UK chart on incorporations and tax reforms

• Look in the Review documents….

Top tax rates and taxable income elasticities

An ‘optimal’ top tax rate (Brewer, Saez and Shephard, MRI)

e – taxable income elasticity

1 / (1 ) h i h Pt = 1 / (1 + a·e) where a is the Pareto parameter.

Estimate e from the evolution of top incomes in tax returnEstimate e from the evolution of top incomes in tax return data following large top MTR reductions in the 1980s

Estimate a (≈ 1.8) from the empirical distribution

Top incomes and taxable income elasticities

A . T o p 1% In co m e S h are an d M T R , 1962-2003

80% 16%

60%

70%

te

14%

40%

50%

nal T

ax R

at

1 0%

12%

ome

Shar

eT o p 1% M T RT o p 1% in co m e sh are

20%

30%

Mar

gin

6%

8% Inco

0%

10%

962

966

970

974

978

982

986

990

994

998

002

4%

6%

19 19 19 19 19 19 19 19 19 19 20

Source: MR1, UK SPI (tax return data)

Taxable Income Elasticities at the TopSimple Difference (top 1%) DD using top 5 1%Simple Difference (top 1%) DD using top 5-1%

as control

1978 vs 1981 0.32 0.081986 vs 1989 0.38 0.411978 1962 0 63 0 861978 vs 1962 0.63 0.862003 vs 1978 0.89 0.64

Full time series 0.69 0.46(0.12) (0.13)

With updated data the estimate remains in the .35 - .55 range with a central estimate of .46, but remain quite fragileNote also the key relationship between the size of elasticity and the tax base (Slemrod and Kopczuk, 2002)

Pareto distribution as an approximation to the income distribution

0.0100

ale)

Pareto distribution

A t l i di t ib ti0.0010

ity (l

og s

ca Actual income distribution

0 0000

0.0001

bilit

y de

ns

0 0000

0.0000

Prob

ab

0.0000£100,000 £150,000 £200,000 £250,000 £300,000 £350,000 £400,000 £450,000 £500,000

Pareto parameter quite accurately estimated at 1.8Pareto parameter quite accurately estimated at 1.8=> revenue maximising tax rate for top 1% of 55%.

Empirical Evidence and Tax Policy Design: Lessons from the Mirrlees Review

Five building blocks for the role of evidence in tax design….

Lessons from the Mirrlees Review

• Key margins of adjustment to tax reform

• Measurement of effective tax rates• Measurement of effective tax rates

• The importance of information, complexity and salience

• Evidence on the size of responses

• Implications for tax design

seehttp://www.ifs.org.uk/mirrleesReview


But (too) many key issues unresolved, and with little evidence base (!)

Including:

• Tax credits and earnings progressionTax credits and earnings progression

• Distinction between dynamic and static policies

H it l i t t bi d i t ti• Human capital investment bias and savings taxation

• Taxation of financial services

• Some transition issues and capitalisation

• ….

Dynamic effects on wages for low income welfare recipients?

8.5

pSSP: Hourly wages by months after RA

88

ges

77.

5rly

real

wa

6.5H

ou6

0 10 20 30 40 50 60Months after random assignment


control experimental

SSP: Monthly earnings by months after RA40

0y g y

004

gs0

30th

ly e

arni

n20

0M

ont

100

0 10 20 30 40 50 60Months after random assignment


control experimental

Evidence from the SSP experiment

• Earnings and employment line up with control group after time limit is exhausted

• Little evidence of employment enhancement or wage progression

• Other evidence Taber etc show some progression but• Other evidence, Taber etc, show some progression but quite small

• Remains a key area of researche a s a ey a ea o esea c


Some Additional References:Banks, J., Blundell, R., and Tanner, S. (1998) “Is there a retirement-savings , , , , , ( ) gpuzzle?”, American Economic Review, 88, 769 – 788.

Besley, T. and S. Coate (1992), “Workfare versus Welfare: Incentive Arguments for Work Requirement in Poverty Alleviation Programs” American Economicfor Work Requirement in Poverty Alleviation Programs , American Economic Review, 82(1), 249-261.

Blundell, R. (2006), “Earned income tax credit policies: Impact and Optimality”, Th 2005 Ad S ith L t L b E i 13 423 443The 2005 Adam Smith Lecture, Labour Economics, 13, 423-443.

Blundell, R.W., Duncan, A. and Meghir, C. (1998), "Estimating Labour Supply Responses using Tax Policy Reforms", Econometrica, 66, 827-861.

Blundell, R, Duncan, A, McCrae, J and Meghir, C. (2000), "The Labour Market Impact of the Working Families' Tax Credit", Fiscal Studies, 21(1).

(200 ) f fBlundell, 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, R. and MaCurdy (1999), "Labour Supply: A Review of Alternative 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 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 WorkingBrewer, 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 W lf R i i t T W k?" R h i L b E i 17 1 56Welfare Recipients To Work?", Research in Labor Economics, 17, pp 1-56.

Chetty, R. (2008), ‘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 13 101-110Public 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.

Immervoll, H. Kleven, H. Kreiner, C, and Saez, E. (2005), `Welfare Reform in European Countries: A Micro-Simulation Analysis’ Economic Journal.

Keane, M.P. and Moffitt, R. (1998), "A Structural Model of Multiple Welfare Program Participation and Labor Supply", International Economic Review, 39(3) 553 58939(3), 553-589.

Kopczuk, W. (2005), ‘Tax bases, tax rates and the elasticity of reported income’, Journal of Public Economics, 89, 2093–119.

Laroque, G. (2005), “Income Maintenance and Labour Force Participation”, Econometrica, 73(2), 341-376.

Mi l J A (1971) “Th Th f O ti l I T ti ” R i fMirrlees, 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) 54-58American 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 10731039-1073.

Sørensen , P. B. (2009) “Dual income taxes: a Nordic tax system”, Paper prepared for the conference on New Zealand Tax Reform – Where to Next?.

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