5 - Optimal Labour Income Taxation Flashcards
what are refundable tax credits
- benefits received as long as they are working - doesnt benefit unemployed
- rewarded with excess taxes that they otherwise would have been owed
assumptions of the simple model
- U(C) is strictly increasing
- U(C) is concave
- Utility function is same for everyone
- income is fixed Z for each individual (people cant change their behaviour)
- assumes no behavioural responses
what does the simple model do
as long as assumptions hold
- perfect equalisation
- everyone gets the same post tax/transfer income
- 100% redistributional
what does the simple model do
equation
maximises the sum of everyones utilities subject to the BC of the governments income (taxes=transfers)
what does the simple model prove
that maximising the utilities = the optimal tax solution is 100% MTR = perfect equalization
what are the issues with the simple model
- no behavioural responses assumption = would destroy all incentive to work - assumption that incomes are fixed would be false as they would fall
- people generally disagree with 100% redistribution = unfair
why should the simple model incorporate fairness
- bounds on how much redistribution the gov can do
what is the equity efficiency trade off
- redistribution = helps equity - reduces inequality
- but at cost of economic inefficiency
- high tax rates = economic inefficiency if there are behavioural responses to tax rates
- behavioural responses limit the amount gov can redistribute
- tradeoff between equity and efficiency
what factor limits the ability of gov to redistribute with taxes and transfers
- the size of behavioural response limits ability to reduce inequality
- equity efficiecny tradeoff
- the more responsive individuals are to the tax - the less they work/more evade/avoid - the less taxes are generated
- taxes create inefficiencies
what is -T(0)
transfer benefit with 0 earnings
lumpsum grant
what is T’(z)
what is 1 - T’(z)
MTR = how much an individual is being taxed for an additional $1 of earnings
1-T’(z) = how much an income they keep for each additional pound
what is the participation tax rate
why is it important
(T(z) - T(0)) / z
it is what fraction an individual keeps of earnings when moving from 0 earnings to z earnings (vertical line on graph)
its important for extensive labour supply responses - when people make decisions on whether to work or not
what is T(Z*)
the break even point
- they get no benefit / loss from taxes or transfers
what is the difference between traditional means tested programs and refundable tax credits
traditional = reduce incentive to work for low income workers - benefit 0 hour workers
tax credit = incentive to work to gain from the benefits - but doesnt help 0 hour workers
what are the 2 different kind of models we can use to choose the optimal tax rate
without behavioural responses = simple model (horizontal line)
with behaviour responses (shallow slope)
what is the labour supply theory
equation
maximise utility (function of consumption and labour)
maxU(C,L)
subject to BC of income
C = w*l + R
what is the income effect
more income = increased consumption and decreased leisure
what is the substitution effect
increased income = the OC of leisure has increased, leisure is more expensive, so will increase labour
what is the difference between marshallian and hicksian labour supply
marshallian = maximise utility s.t BC
hicksian = minimise labour needed to reach utility given wage slope
what is uncompensated elasticity
substitution effect
considers only the response to price changes - doesnt consider the adjustment of consumers income
what is the Slutsky equation
eU = eC + income effect
what does
T(z) > 0
T(z) <0 mean
- net taxes
- net transfers