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Emmanuel HANSEN - LUDWIG MAXIMILIANS UNIVERSITAT MUNCHEN

"Self-Financing Tax Cuts Around the World : New Theoretical Results and Applications"

Abstract :
This paper studies whether tax-transfer systems are inefficient in the sense of allowing for self-financing tax cuts. In the first part, we combine household micro data from representative surveys with tax-transfer calculators for 33 countries around the world. We show that, with standard labor supply elasticities, self-financing tax cuts exist for all 29 countries in which the effective marginal tax rates (EMTR) exhibit sudden drops. In the second part, we show analytically that sudden drops in EMTRs give rise to inefficiencies whenever (a) taxpayers are rational and have additively separable preferences, or (b) taxpayers use the ironing heuristic and EMTRs are above some threshold. In the third part, we characterize discrete tax reforms that bring inefficient tax-transfer systems to the Pareto frontier. For this purpose, we focus on a canonical model with iso-elastic and quasi-linear preferences and consider both rational and non-rational taxpayers. Thereby, we provide an empirically applicable recipe how to design tax reforms that raise tax revenue without making any individual in society worse off.

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