For simplicity, the discussion ignores noncorporate firms. 6. In Canada, there is a dividend cred... more For simplicity, the discussion ignores noncorporate firms. 6. In Canada, there is a dividend credit, which reduces the extent of the double taxation inherent in this tax structure. 7. In all cases, the credit is not refundable, so is limited to the amount of taxes due in the home country on that income. For further detail on U.S. and Canadian provisions, see Boadway and Bruce (ch. 1 in this volume). 8. This last assumption may not be that unreasonable. Hines and Hubbard (1990) provide evidence that U.S. multinationals, at least, pay little or no U.S. taxes on their repatriated earnings.
To what degree do economists disagree about key economic questions? To provide evidence, we make ... more To what degree do economists disagree about key economic questions? To provide evidence, we make use of the responses to a series of questions posed to a distinguished panel of economists put together by the Chicago School of Business. Based on our analysis, we find a broad consensus on these many different economic issues, particularly when the past economic literature on the question is large. Any differences are unrelated to observable characteristics of the Panel members, other than men being slightly more likely to express an opinion. These differences are idiosyncratic, with no support for liberal vs. conservative camps.
In this paper, we derive a measure of the efficiency cost of taxing risky capital income in an in... more In this paper, we derive a measure of the efficiency cost of taxing risky capital income in an infinite horizon stochastic model. The resulting measure differs from all those that have been proposed in the existing literature. It can be represented by the expression-. , T,"c(EX.), where T1 measures the present value of the taxes that would be paid on a unit of investment in a riskless project with the same expected depreciation rate and tax treatment as capital invested in period s, X,, while c(X8) represents the certainty equivalent to the representative individual of the lottery where measures the ex post change in investment in period s due to the tax change. The paper then compares this measure with others that have appeared in the literature. We were unable to find support for the argument in Bulow-Suinmers(1984) that the efficiency cost of taxing risky capital income is much larger than that implied by the measure-E. T'E(AX.). In fact, we show in special cases that our measure implies a smaller efficiency cost than does the measure
Cash-flow taxes have been advocated as efficient, equitable, and easy to administer. In principle... more Cash-flow taxes have been advocated as efficient, equitable, and easy to administer. In principle, at least, they do not distort savings and investment decisions. But what are the praztical implications of the many versions of cash-flow taxation? The Policy, Planning, and Research Complex distributes PPR Working Papers to dissermnate the findings of work in progress and to enmourage the exchange of ideas amonag Bank staff and aU others interested in development issues. These papers carry the names of the authors, refled only their views, and should be used and cited accordingly. The findings, interpretations, and conclusions are thc authors own. They should not he attributed to the World Bank, its Bo2rd of Directors, its management, or any of its mernber countries
To what degree will dropping trade barriers create pressure on the U.S. and Canada to harmonize t... more To what degree will dropping trade barriers create pressure on the U.S. and Canada to harmonize their tax systems? Which aspects of their tax systems will be most affected? Will this harmomzation occur on its own, as each country finds it in its economic interest to choose tax provisions resembling those in the other country? When will explicit coordination of tax provisions be called for? What pressures towards harmonization exist even with existing trade barriers? Addressing these questions is the objective of this paper. The answers to these questions depend to some extent on the degree to which the U.S. aMd Canadian economies are linked. Even when different economics are totally linked, as are cities and regions in a national economy, these different communities can still maintain distinct tax rates and even tax structures. There has developed a large literature exploring the characteristics of equilibrium tax structures in this setting, stimulated by Tiebout(1956). These models assume that everything and everyone is mobileimnplicitly, even community boundaries can adjust. The basic conclusion of this literature is that competition among communmities drives the tax system towards one in which each individual's or firm's tax payment closely matches the cost of the services received from the conmunnity (or the costs imposed on the community from, e.g., pollution or congestion), a tax system known in the literature as benefit taxation.) With any other tax structure, decisiuns in one community clearly affect welfare in other communities, creating the potential for mutually beneficial coordination of fiscal policies. 2 Even before the recent free-trade agreement between the U.S. and Canada, these two national economics were closely linked. To begin with, the capital markets were highly Much of this paper was written while I was visiting the Universidadel Nova de L.isboa. I would like to thank the other participants in the Canada-U.S. Tax Comparisons project, and especially John Shoven sail Juln Whalley, for comments on a previous draft. 1To the degree to which a community's taxes deviate from benefit taxes, other communities have the itncentiive to hid to attract those individuals or firms who on net pay more than they impose in costs on the communCity. Vor further discussion, see Hluchanan-Coetz(1972). 2 See Corlon(1933) for an exploration of the various possible sources of cxternalities. integrated, allowing individuals and firms to shift their savings from one country to the other without restrictions. Trade in goods was substantial. While migration of individuals does not occur on a large scale, it certainly occurs. The free-trnde agreement will lead to a further integration of the two economies. To what degree will these economic links drive the two tax systems towards a benefit-tax structure? What externalities are likely to remain, creating room for mutually beneficial coordination of fiscal policies?' To explore this question, the paper proceeds in stages. In section 1, only capital mobility is allowed for. What implications does this link alone have on domestic tax policies, and the need for tax harmonization? Section 2 examines what further pressures are created by free trade in the full range of outputs. Finally, in section 3, labor mobility is allowed for as well. A brief conclusion ends the paper. 1. Tax implications of capital mobility This section explores how capital mobility affects the design of tax policy in each of the two countries. To explore this question, assume for simplicity that only one good is traded between the two countries. Trade therefore simply takes the form of some of this good being imported now, in return for an acceptable amount of this good being exlorted back as return payment int a later period. To shorten the discussion, I will ignore the implications of risk or inflation. Without taxes, capital would flow between the two countries until the rate of return from investing in each country is the same. Let i! represent the rate of return on asset n in country j. Without taxes and uncertainty, the return on all assets would be equalized in eqtuilibriun, so that im = it for any asset a in country j and asset b in country k. Civen this, investors would be indifferent between investing in domestic or foreign cal>ital, and between investing in different types of financial securities. Thne equilibrium owvnership structure of securities, and the equilibrium allocation of capital, can be affected in many ways by the tax systems in the two countries. The existing tax treatment of capital income is quite complex. To begin with, a corporation's v hile the paper will often refer to the beneficial coordination of fiscal policies as tax armioizant, this coordination does not necessarily imply equalization of tax rates.
Starting with Vickrey (1945) and Mirrlees (1971), the optimal tax literature has studied the desi... more Starting with Vickrey (1945) and Mirrlees (1971), the optimal tax literature has studied the design of a personal income tax. The assumed ideal would be to tax earnings ability. Earnings ability is unobservable for tax purposes, however. Past papers have focused instead on designing a tax on labor income. Existing tax bases, though, depend on a broader range of information about each individual than just labor income. In principle, this supplementary information can help in designing a tax that has more attractive distributional properties, by more closely approximating an ability tax. The objective of this paper is to lay out theoretically and estimate empirically how to make best use of available information about each individual in addition to earnings, in a setting where the first-best tax would be an ability tax. The theory lays out an equity/efficiency trade off when choosing the tax base. In the empirical work, we find the tax base that is best on equity grounds alone. We find that the choice to tax couples based on their joint income, and the inclusion of dividends, interest income, and dependents' deduction in the tax base in roughly their current form can be rationalized simply based on their value in better approximating an ability tax, without any need for supplementary motivations for these provisions. However, the inclusion of mortgage and property tax payments in the list of itemized deductions cannot be defended on these grounds.
This paper makes use of individual data for 2004 to 2008 on owners of closely-held businesses in ... more This paper makes use of individual data for 2004 to 2008 on owners of closely-held businesses in Sweden to estimate the role of both tax and non-tax determinants in the choice to be a closely-held corporation vs. a proprietorship. While lower-income individuals face relatively neutral incentives, higher income households face strong tax incentives to be corporate. The data suggest a strong response to these tax incentives. Many conventional non-tax determinants are confirmed in the data as well.
Observed economic policies in developing countries differ sharply both from those observed among ... more Observed economic policies in developing countries differ sharply both from those observed among developed countries and from those forecast by existing models of optimal policies. For example, developing countries rely little on broad-based taxes, and make substantial use of tariffs and seignorage as nontax sources of revenue. The objective of this paper is to contrast the implications of two models designed to explain such anomalous policies. One approach, by Gordon-Li (2005), focuses on the greater difficulties faced in poor countries in monitoring taxable activity, and explores the best available policies given such difficulties. The other, building on Grossman-Helpman (1994), presumes that political-economy problems in developing countries are worse, leading to worse policy choices. The paper compares the contrasting theoretical implications of the two models with the data, and finds that the politicaleconomy approach does poorly in reconciling many aspects of the data with the theory. In contrast, the forecasts from Gordon-Li model are largely consistent with the data currently available.
We thank Campbell Harvey and Jim Wang for comments and suggestions, Michael Wu and Yan Yu for res... more We thank Campbell Harvey and Jim Wang for comments and suggestions, Michael Wu and Yan Yu for research assistance. Wei Li acknowledges the financial support from the Center for Business Education and Research at Duke University. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
and participants at presentations at Tsinghua University, the NBER pre-conference in Cambridge MA... more and participants at presentations at Tsinghua University, the NBER pre-conference in Cambridge MA, and the NBER-CUHK conference in Hong Kong on "Capitalizing China." We would like to thank CKGSB for its hospitality and financial support. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue... more Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue/GDP is surprisingly small compared with that in developed economies. Taxes on labor income play a minor role. Taxes on consumption are important, but effective tax rates vary dramatically by firm, with many firms avoiding taxes entirely by operating through cash in the informal economy and others facing very high liabilities. Taxes on capital are an important source of revenue, as are tariffs and seignorage, all contrary to the theoretical literature. In this paper, we argue that all of these aspects of policy may be sensible responses if a government is able in practice to collect taxes only from those firms that make use of the financial sector. Through use of the financial sector, firms generate a paper trail, facilitating tax enforcement. The threat of disintermediation then limits how much can be collected in taxes. Taxes can most easily be collected from the firms most dependent on the financial sector, presumably capital-intensive firms. Given the resulting differential tax rates by sector, other policies would sensibly be used to offset these tax distortions. Tariff protection for capital-intensive firms is one. Inflation, imposing a tax on the cash economy is another.
In a Federal system of government, each unit of government decides independently how much of each... more In a Federal system of government, each unit of government decides independently how much of each type of public good to provide, and what types of taxes, and which tax rates, to use in funding the public goods. In this paper we explore what types of problems can arise from this decentralized form of decision-making. In particular, we describe systematically the types of externalities that one unit of government can create for nonresidents, through both its public goods decisions and its taxation decisions. The paper also explores briefly what the central government might do to lessen the costs of decentralized decision-making.
Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue... more Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue/GDP is surprisingly small compared with that in developed economies. Taxes on labor income play a minor role. Taxes on consumption are important, but effective tax rates vary dramatically by firm, with many firms avoiding taxes entirely by operating through cash in the informal economy and others facing very high liabilities. Taxes on capital are an important source of revenue, as are tariffs and seignorage, all contrary to the theoretical literature. In this paper, we argue that all of these aspects of policy may be sensible responses if a government is able in practice to collect taxes only from those firms that make use of the financial sector. Through use of the financial sector, firms generate a paper trail, facilitating tax enforcement. The threat of disintermediation then limits how much can be collected in taxes. Taxes can most easily be collected from the firms most dependent on the financial sector, presumably capital-intensive firms. Given the resulting differential tax rates by sector, other policies would sensibly be used to offset these tax distortions. Tariff protection for capital-intensive firms is one. Inflation, imposing a tax on the cash economy is another.
In the United States, local government expenditures are heavily subsidized through a variety of s... more In the United States, local government expenditures are heavily subsidized through a variety of sources. This paper explores theoretically and then simulates empirically the effects of eliminating either of two federal subsidies encouraging local government expenditures: (1) income tax deductibility of local tax payments, and (2) the tax exempt status of interest on municipal bonds. We find that eliminating the deductibility of local taxes raises the utility of all income groups, and of home owners as well as of renters. Making interest on municipal bonds taxable, however, substantially hurts the very rich, who lose a tax shelter, and may hurt the very poor, who pay more for municipal services. While most people gain, the net gain is very small.
Numerous previous studies have used sibling correlations to measure the importance of family back... more Numerous previous studies have used sibling correlations to measure the importance of family background as a determinant of economic status. These studies. however, have been biased by several flaws: failure to separate permanent from transitory status variation (including that from measurement error). failure to account for life-cycle stage. and overly homogeneous samples. This paper presents a methodology to address these problems and applies it to longitudinal data from the Panel Study of Income Dynamics. Our main conclusion is that family background appears to exert greater influence on economic status than has been indicated by earlier research.
Why is interest income taxed more heavily than other forms of capital income? This differential t... more Why is interest income taxed more heavily than other forms of capital income? This differential tax treatment has generated substantial tax arbitrage, resulting in lower tax revenue, efficiency costs, and apparently net gains to rich borrowers and net losses to poor lenders, together suggesting that this tax treatment makes no sense on welfare grounds. In examining this argument more formally, this paper reveals two omitted considerations that can help explain the existing tax treatment. First, the forecasted increase in the market interest rate results in a redistribution from rich borrowers to poor lenders. Yet this redistribution comes at no marginal efficiency cost, starting from a situation with no distortions to portfolio choice, so at the margin dominates further redistribution through the income tax. In addition, information about an individual's portfolio choice reveals information about her earnings ability, even controlling for observed labor income, if those who are more able tend to be less risk averse. By making use of this extra information about earnings ability, the tax system can be better tailored to redistribute from able to less able, for any given efficiency cost.
The empirical literature that seeks to measure the effective tax rate on new investment offers a ... more The empirical literature that seeks to measure the effective tax rate on new investment offers a striking paradox. On the one hand, summary measures of the effective tax rate on new investment are normally quite high. On the other hand, the amount of revenue actually collected from taxing capital income is apparently very low. In this paper we derive explicitly how revenue figures (under the existing system and under a hypothetical R-base tax) can be used to construct an estimate of the true effective tax rate on capital income, and how this measure and existing measures are affected by several factors, including resale of assets (churning), risk, pure profits, debt finance and arbitrage, and choice of organizational form.We conclude that our new methodology provides a very useful, but not fail-safe, approach for measuring the effective tax rate on new investment. It is much more robust than the standard measures, such as King-Fullerton marginal effective tax rates, to many commonly omitted complications in the tax law. In trying to reconcile the high conventional measures of the effective tax rate with the low revenue collected, we conclude that the effective tax rate does seem to be much lower than existing measures suggest.
Several recent papers argue that corporate income taxes should not be used by small, open economi... more Several recent papers argue that corporate income taxes should not be used by small, open economies. With capital mobility, the burden of the tax falls on fixed factors (e.g., labor), and the tax system is more efficient if labor is taxed directly. However, corporate taxes not only exist but rates are roughly comparable with the top personal tax rates. Past models also forecast that multinationals should not invest in countries with low corporate tax rates, since the surtax they owe when profits are repatriated puts them at a competitive disadvantage. Yet such foreign direct investment is substantial. We suggest that the resolution of these puzzles may be found in the role of income shifting, both domestic (between the personal and corporate tax bases) and cross-border (through transfer pricing). Countries need cash-flow corporate taxes as a backstop to labor taxes to discourage individuals from converting their labor income into otherwise untaxed corporate income. We explore how these taxes can best be modified to deal as well with cross-border shifting.
For simplicity, the discussion ignores noncorporate firms. 6. In Canada, there is a dividend cred... more For simplicity, the discussion ignores noncorporate firms. 6. In Canada, there is a dividend credit, which reduces the extent of the double taxation inherent in this tax structure. 7. In all cases, the credit is not refundable, so is limited to the amount of taxes due in the home country on that income. For further detail on U.S. and Canadian provisions, see Boadway and Bruce (ch. 1 in this volume). 8. This last assumption may not be that unreasonable. Hines and Hubbard (1990) provide evidence that U.S. multinationals, at least, pay little or no U.S. taxes on their repatriated earnings.
To what degree do economists disagree about key economic questions? To provide evidence, we make ... more To what degree do economists disagree about key economic questions? To provide evidence, we make use of the responses to a series of questions posed to a distinguished panel of economists put together by the Chicago School of Business. Based on our analysis, we find a broad consensus on these many different economic issues, particularly when the past economic literature on the question is large. Any differences are unrelated to observable characteristics of the Panel members, other than men being slightly more likely to express an opinion. These differences are idiosyncratic, with no support for liberal vs. conservative camps.
In this paper, we derive a measure of the efficiency cost of taxing risky capital income in an in... more In this paper, we derive a measure of the efficiency cost of taxing risky capital income in an infinite horizon stochastic model. The resulting measure differs from all those that have been proposed in the existing literature. It can be represented by the expression-. , T,"c(EX.), where T1 measures the present value of the taxes that would be paid on a unit of investment in a riskless project with the same expected depreciation rate and tax treatment as capital invested in period s, X,, while c(X8) represents the certainty equivalent to the representative individual of the lottery where measures the ex post change in investment in period s due to the tax change. The paper then compares this measure with others that have appeared in the literature. We were unable to find support for the argument in Bulow-Suinmers(1984) that the efficiency cost of taxing risky capital income is much larger than that implied by the measure-E. T'E(AX.). In fact, we show in special cases that our measure implies a smaller efficiency cost than does the measure
Cash-flow taxes have been advocated as efficient, equitable, and easy to administer. In principle... more Cash-flow taxes have been advocated as efficient, equitable, and easy to administer. In principle, at least, they do not distort savings and investment decisions. But what are the praztical implications of the many versions of cash-flow taxation? The Policy, Planning, and Research Complex distributes PPR Working Papers to dissermnate the findings of work in progress and to enmourage the exchange of ideas amonag Bank staff and aU others interested in development issues. These papers carry the names of the authors, refled only their views, and should be used and cited accordingly. The findings, interpretations, and conclusions are thc authors own. They should not he attributed to the World Bank, its Bo2rd of Directors, its management, or any of its mernber countries
To what degree will dropping trade barriers create pressure on the U.S. and Canada to harmonize t... more To what degree will dropping trade barriers create pressure on the U.S. and Canada to harmonize their tax systems? Which aspects of their tax systems will be most affected? Will this harmomzation occur on its own, as each country finds it in its economic interest to choose tax provisions resembling those in the other country? When will explicit coordination of tax provisions be called for? What pressures towards harmonization exist even with existing trade barriers? Addressing these questions is the objective of this paper. The answers to these questions depend to some extent on the degree to which the U.S. aMd Canadian economies are linked. Even when different economics are totally linked, as are cities and regions in a national economy, these different communities can still maintain distinct tax rates and even tax structures. There has developed a large literature exploring the characteristics of equilibrium tax structures in this setting, stimulated by Tiebout(1956). These models assume that everything and everyone is mobileimnplicitly, even community boundaries can adjust. The basic conclusion of this literature is that competition among communmities drives the tax system towards one in which each individual's or firm's tax payment closely matches the cost of the services received from the conmunnity (or the costs imposed on the community from, e.g., pollution or congestion), a tax system known in the literature as benefit taxation.) With any other tax structure, decisiuns in one community clearly affect welfare in other communities, creating the potential for mutually beneficial coordination of fiscal policies. 2 Even before the recent free-trade agreement between the U.S. and Canada, these two national economics were closely linked. To begin with, the capital markets were highly Much of this paper was written while I was visiting the Universidadel Nova de L.isboa. I would like to thank the other participants in the Canada-U.S. Tax Comparisons project, and especially John Shoven sail Juln Whalley, for comments on a previous draft. 1To the degree to which a community's taxes deviate from benefit taxes, other communities have the itncentiive to hid to attract those individuals or firms who on net pay more than they impose in costs on the communCity. Vor further discussion, see Hluchanan-Coetz(1972). 2 See Corlon(1933) for an exploration of the various possible sources of cxternalities. integrated, allowing individuals and firms to shift their savings from one country to the other without restrictions. Trade in goods was substantial. While migration of individuals does not occur on a large scale, it certainly occurs. The free-trnde agreement will lead to a further integration of the two economies. To what degree will these economic links drive the two tax systems towards a benefit-tax structure? What externalities are likely to remain, creating room for mutually beneficial coordination of fiscal policies?' To explore this question, the paper proceeds in stages. In section 1, only capital mobility is allowed for. What implications does this link alone have on domestic tax policies, and the need for tax harmonization? Section 2 examines what further pressures are created by free trade in the full range of outputs. Finally, in section 3, labor mobility is allowed for as well. A brief conclusion ends the paper. 1. Tax implications of capital mobility This section explores how capital mobility affects the design of tax policy in each of the two countries. To explore this question, assume for simplicity that only one good is traded between the two countries. Trade therefore simply takes the form of some of this good being imported now, in return for an acceptable amount of this good being exlorted back as return payment int a later period. To shorten the discussion, I will ignore the implications of risk or inflation. Without taxes, capital would flow between the two countries until the rate of return from investing in each country is the same. Let i! represent the rate of return on asset n in country j. Without taxes and uncertainty, the return on all assets would be equalized in eqtuilibriun, so that im = it for any asset a in country j and asset b in country k. Civen this, investors would be indifferent between investing in domestic or foreign cal>ital, and between investing in different types of financial securities. Thne equilibrium owvnership structure of securities, and the equilibrium allocation of capital, can be affected in many ways by the tax systems in the two countries. The existing tax treatment of capital income is quite complex. To begin with, a corporation's v hile the paper will often refer to the beneficial coordination of fiscal policies as tax armioizant, this coordination does not necessarily imply equalization of tax rates.
Starting with Vickrey (1945) and Mirrlees (1971), the optimal tax literature has studied the desi... more Starting with Vickrey (1945) and Mirrlees (1971), the optimal tax literature has studied the design of a personal income tax. The assumed ideal would be to tax earnings ability. Earnings ability is unobservable for tax purposes, however. Past papers have focused instead on designing a tax on labor income. Existing tax bases, though, depend on a broader range of information about each individual than just labor income. In principle, this supplementary information can help in designing a tax that has more attractive distributional properties, by more closely approximating an ability tax. The objective of this paper is to lay out theoretically and estimate empirically how to make best use of available information about each individual in addition to earnings, in a setting where the first-best tax would be an ability tax. The theory lays out an equity/efficiency trade off when choosing the tax base. In the empirical work, we find the tax base that is best on equity grounds alone. We find that the choice to tax couples based on their joint income, and the inclusion of dividends, interest income, and dependents' deduction in the tax base in roughly their current form can be rationalized simply based on their value in better approximating an ability tax, without any need for supplementary motivations for these provisions. However, the inclusion of mortgage and property tax payments in the list of itemized deductions cannot be defended on these grounds.
This paper makes use of individual data for 2004 to 2008 on owners of closely-held businesses in ... more This paper makes use of individual data for 2004 to 2008 on owners of closely-held businesses in Sweden to estimate the role of both tax and non-tax determinants in the choice to be a closely-held corporation vs. a proprietorship. While lower-income individuals face relatively neutral incentives, higher income households face strong tax incentives to be corporate. The data suggest a strong response to these tax incentives. Many conventional non-tax determinants are confirmed in the data as well.
Observed economic policies in developing countries differ sharply both from those observed among ... more Observed economic policies in developing countries differ sharply both from those observed among developed countries and from those forecast by existing models of optimal policies. For example, developing countries rely little on broad-based taxes, and make substantial use of tariffs and seignorage as nontax sources of revenue. The objective of this paper is to contrast the implications of two models designed to explain such anomalous policies. One approach, by Gordon-Li (2005), focuses on the greater difficulties faced in poor countries in monitoring taxable activity, and explores the best available policies given such difficulties. The other, building on Grossman-Helpman (1994), presumes that political-economy problems in developing countries are worse, leading to worse policy choices. The paper compares the contrasting theoretical implications of the two models with the data, and finds that the politicaleconomy approach does poorly in reconciling many aspects of the data with the theory. In contrast, the forecasts from Gordon-Li model are largely consistent with the data currently available.
We thank Campbell Harvey and Jim Wang for comments and suggestions, Michael Wu and Yan Yu for res... more We thank Campbell Harvey and Jim Wang for comments and suggestions, Michael Wu and Yan Yu for research assistance. Wei Li acknowledges the financial support from the Center for Business Education and Research at Duke University. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
and participants at presentations at Tsinghua University, the NBER pre-conference in Cambridge MA... more and participants at presentations at Tsinghua University, the NBER pre-conference in Cambridge MA, and the NBER-CUHK conference in Hong Kong on "Capitalizing China." We would like to thank CKGSB for its hospitality and financial support. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue... more Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue/GDP is surprisingly small compared with that in developed economies. Taxes on labor income play a minor role. Taxes on consumption are important, but effective tax rates vary dramatically by firm, with many firms avoiding taxes entirely by operating through cash in the informal economy and others facing very high liabilities. Taxes on capital are an important source of revenue, as are tariffs and seignorage, all contrary to the theoretical literature. In this paper, we argue that all of these aspects of policy may be sensible responses if a government is able in practice to collect taxes only from those firms that make use of the financial sector. Through use of the financial sector, firms generate a paper trail, facilitating tax enforcement. The threat of disintermediation then limits how much can be collected in taxes. Taxes can most easily be collected from the firms most dependent on the financial sector, presumably capital-intensive firms. Given the resulting differential tax rates by sector, other policies would sensibly be used to offset these tax distortions. Tariff protection for capital-intensive firms is one. Inflation, imposing a tax on the cash economy is another.
In a Federal system of government, each unit of government decides independently how much of each... more In a Federal system of government, each unit of government decides independently how much of each type of public good to provide, and what types of taxes, and which tax rates, to use in funding the public goods. In this paper we explore what types of problems can arise from this decentralized form of decision-making. In particular, we describe systematically the types of externalities that one unit of government can create for nonresidents, through both its public goods decisions and its taxation decisions. The paper also explores briefly what the central government might do to lessen the costs of decentralized decision-making.
Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue... more Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue/GDP is surprisingly small compared with that in developed economies. Taxes on labor income play a minor role. Taxes on consumption are important, but effective tax rates vary dramatically by firm, with many firms avoiding taxes entirely by operating through cash in the informal economy and others facing very high liabilities. Taxes on capital are an important source of revenue, as are tariffs and seignorage, all contrary to the theoretical literature. In this paper, we argue that all of these aspects of policy may be sensible responses if a government is able in practice to collect taxes only from those firms that make use of the financial sector. Through use of the financial sector, firms generate a paper trail, facilitating tax enforcement. The threat of disintermediation then limits how much can be collected in taxes. Taxes can most easily be collected from the firms most dependent on the financial sector, presumably capital-intensive firms. Given the resulting differential tax rates by sector, other policies would sensibly be used to offset these tax distortions. Tariff protection for capital-intensive firms is one. Inflation, imposing a tax on the cash economy is another.
In the United States, local government expenditures are heavily subsidized through a variety of s... more In the United States, local government expenditures are heavily subsidized through a variety of sources. This paper explores theoretically and then simulates empirically the effects of eliminating either of two federal subsidies encouraging local government expenditures: (1) income tax deductibility of local tax payments, and (2) the tax exempt status of interest on municipal bonds. We find that eliminating the deductibility of local taxes raises the utility of all income groups, and of home owners as well as of renters. Making interest on municipal bonds taxable, however, substantially hurts the very rich, who lose a tax shelter, and may hurt the very poor, who pay more for municipal services. While most people gain, the net gain is very small.
Numerous previous studies have used sibling correlations to measure the importance of family back... more Numerous previous studies have used sibling correlations to measure the importance of family background as a determinant of economic status. These studies. however, have been biased by several flaws: failure to separate permanent from transitory status variation (including that from measurement error). failure to account for life-cycle stage. and overly homogeneous samples. This paper presents a methodology to address these problems and applies it to longitudinal data from the Panel Study of Income Dynamics. Our main conclusion is that family background appears to exert greater influence on economic status than has been indicated by earlier research.
Why is interest income taxed more heavily than other forms of capital income? This differential t... more Why is interest income taxed more heavily than other forms of capital income? This differential tax treatment has generated substantial tax arbitrage, resulting in lower tax revenue, efficiency costs, and apparently net gains to rich borrowers and net losses to poor lenders, together suggesting that this tax treatment makes no sense on welfare grounds. In examining this argument more formally, this paper reveals two omitted considerations that can help explain the existing tax treatment. First, the forecasted increase in the market interest rate results in a redistribution from rich borrowers to poor lenders. Yet this redistribution comes at no marginal efficiency cost, starting from a situation with no distortions to portfolio choice, so at the margin dominates further redistribution through the income tax. In addition, information about an individual's portfolio choice reveals information about her earnings ability, even controlling for observed labor income, if those who are more able tend to be less risk averse. By making use of this extra information about earnings ability, the tax system can be better tailored to redistribute from able to less able, for any given efficiency cost.
The empirical literature that seeks to measure the effective tax rate on new investment offers a ... more The empirical literature that seeks to measure the effective tax rate on new investment offers a striking paradox. On the one hand, summary measures of the effective tax rate on new investment are normally quite high. On the other hand, the amount of revenue actually collected from taxing capital income is apparently very low. In this paper we derive explicitly how revenue figures (under the existing system and under a hypothetical R-base tax) can be used to construct an estimate of the true effective tax rate on capital income, and how this measure and existing measures are affected by several factors, including resale of assets (churning), risk, pure profits, debt finance and arbitrage, and choice of organizational form.We conclude that our new methodology provides a very useful, but not fail-safe, approach for measuring the effective tax rate on new investment. It is much more robust than the standard measures, such as King-Fullerton marginal effective tax rates, to many commonly omitted complications in the tax law. In trying to reconcile the high conventional measures of the effective tax rate with the low revenue collected, we conclude that the effective tax rate does seem to be much lower than existing measures suggest.
Several recent papers argue that corporate income taxes should not be used by small, open economi... more Several recent papers argue that corporate income taxes should not be used by small, open economies. With capital mobility, the burden of the tax falls on fixed factors (e.g., labor), and the tax system is more efficient if labor is taxed directly. However, corporate taxes not only exist but rates are roughly comparable with the top personal tax rates. Past models also forecast that multinationals should not invest in countries with low corporate tax rates, since the surtax they owe when profits are repatriated puts them at a competitive disadvantage. Yet such foreign direct investment is substantial. We suggest that the resolution of these puzzles may be found in the role of income shifting, both domestic (between the personal and corporate tax bases) and cross-border (through transfer pricing). Countries need cash-flow corporate taxes as a backstop to labor taxes to discourage individuals from converting their labor income into otherwise untaxed corporate income. We explore how these taxes can best be modified to deal as well with cross-border shifting.
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Papers by Roger Gordon