- 22 Jun 2011
- Working Paper Summaries
The Surprising Power of Age-Dependent Taxes
Professor Matthew Weinzierl helps initiate a resurgence of interest in the idea of age-dependent taxes—that is, the idea of making the tax rate contingent upon the age of the tax payer. Using optimal tax theory as well as data from the US Panel Study of Income Dynamics, he shows how the administratively simple reform of age dependence can make the tax system substantially more efficient and more equitable. Key concepts include: Age-dependent marginal tax rates are tailored to the distribution of income at each age. To see why, note that a 25-year-old earning $100,000 is higher in his or her age-specific income distribution than is a 45-year-old earning $100,000. Furthermore, these two workers are likely to have a different lifetime earnings path. We therefore ought to tax them differently. Age-dependent average tax rates can help individuals transfer earnings across the lifecycle when private borrowing and saving is restricted. Age dependence yields a large welfare gain by reducing distortions (lower marginal tax rates) and by making possible more redistribution. Closed for comment; 0 Comments.
- 17 Feb 2011
- Working Paper Summaries
Preference Heterogeneity and Optimal Capital Income Taxation
Professor Matthew Weinzierl and coauthors test the idea that savings, which is concentrated among highly skilled workers, ought to be taxed as part of an optimal tax policy. They find that the welfare gains from these taxes would be negligible. Key concepts include: Is taxing capital income (the return to saving) a good idea when highly skilled people value that income more than others? A baseline simulation finds that the optimal capital income taxes are modest--only 2 percent on average and 4.5 percent on high earners. Welfare gains from these optimal capital income taxes would be negligible. Closed for comment; 0 Comments.
- 08 Sep 2009
- Research & Ideas
The Height Tax, and Other New Ways to Think about Taxation
The notion of levying higher taxes on tall people—an idea offered largely tongue in cheek—presents an ideal way to highlight the shortcomings of current tax policy and how to make it better. Harvard Business School professor Matthew C. Weinzierl looks at modern trends in taxation. Key concepts include: Studies show that each inch of height is associated with about a 2 percent higher wage among white males in the United States. If we as a society are uncomfortable taxing height, maybe we should reconsider our comfort level for taxing ability (as currently happens with the progressive income tax). For Weinzierl, the key to explaining the apparent disconnect between theory and intuition starts with the particular goal for tax policy assumed in the standard framework. That goal is to minimize the total sacrifice borne by those who pay taxes. Behind the scenes, important trends are evolving in tax policy. Value-added taxes, for example, are generally seen as efficient by tax economists, but such taxes can bear heavily on the poor if not balanced with other changes to the system. Closed for comment; 0 Comments.
- 19 Aug 2009
- Working Paper Summaries
Optimal Taxation in Theory and Practice
Are developments in the theory of taxation improving tax policies around the world? The optimal design of a tax system is a topic that has long fascinated economic theorists and flummoxed economic policymakers. This paper explores the interplay between tax theory and tax policy. It identifies key lessons policymakers might take from the academic literature on how taxes ought to be designed, and it discusses the extent to which these lessons are reflected in actual tax policy. The authors find that there has been considerable change in the theory and practice of taxation over the past several decades—although the two paths have been far from parallel. Overall, tax policy has moved in the directions suggested by theory along a few dimensions, even though the recommendations of theory along these dimensions are not always definitive. Key concepts include: Where large gaps between theory and policy remain, the harder question is whether policymakers need to learn more from theorists, or the other way around. Both possibilities have historical precedents. Given the worldwide trend toward tax systems with flatter tax rates, it is at least arguable that the movement toward flatter taxes is consistent with prescriptions from theory. Among OECD countries, top marginal rates have declined, marginal income tax schedules have flattened, and commodity taxes are more uniform and are typically assessed on final goods. On the other hand, some results from optimal tax theory cannot be easily identified in actual policy and seem unlikely to be found there anytime soon. Trends in capital taxation are mixed, and rates are still well above the zero level recommended by theory. Some of theory's more subtle prescriptions, such as taxes that involve personal characteristics, asset testing, and history dependence, remain rare. Closed for comment; 0 Comments.
- 19 Aug 2009
- Working Paper Summaries
The Optimal Taxation of Height: A Case Study of Utilitarian Income Redistribution
A tax on height follows inexorably from a well-established empirical regularity and the standard approach to the optimal design of tax policy. Many readers of this paper, however, will not so quickly embrace the idea of levying higher taxes on tall taxpayers. Indeed, when first hearing the proposal, most people either recoil from it or are amused by it. That reaction is precisely what makes tax policy so intriguing, according to N. Gregory Mankiw of Harvard University and Matthew Weinzierl of HBS. This paper addresses a classic problem: the optimal redistribution of income. A Utilitarian social planner would like to transfer resources from high-ability individuals to low-ability individuals, but is constrained by the fact that he cannot directly observe ability. Taxing height helps the planner achieve redistribution efficiently because height, the data show, is an indicator of income-earning ability. Although readers might take this paper in one of two ways—some seeing it as a small, quirky contribution aimed to clarify the literature on optimal income taxation, others as a broader effort to challenge the entire literature—the authors' results raise a fundamental question about the framework for optimal taxation for which William Vickrey and James Mirrlees won the 1996 Nobel Prize in Economics and which remains a centerpiece of modern public finance. Key concepts include: We must either advocate a tax on height or reject, or at least significantly amend, the conventional Utilitarian approach to optimal taxation. Such choices cannot be avoided. Calculations show that a Utilitarian social planner should levy a sizable tax on height. A tall person making $50,000 should pay about $4,500 more in taxes than a short person making the same income. Height is, of course, only one of many possible personal characteristics that are correlated with a person's opportunities to produce income. In this paper, the authors have avoided these other variables, such as race and gender, because they are intertwined with a long history of discrimination. Any discussion of using these variables in tax policy would raise various political and philosophical issues that go beyond the scope of this paper. Some might fear that a height tax would potentially become a "gateway" tax for the government, making taxes based on demographic characteristics more natural and dangerously expanding the scope for government information collection and policy personalization. Yet modern tax systems already condition on much personal information, such as number of children, marital status, and personal disabilities. A height tax is qualitatively similar, so it is difficult to see why it would trigger a sudden descent down a slippery slope. Closed for comment; 0 Comments.
An Exploration of Optimal Stabilization Policy
The researchers explore alternative policy responses to a recession caused by a decline in aggregate demand, the situation affecting the global economy over the last several years. They show that policies that stimulate the economy at the lowest budgetary cost may not be the best policies in terms of well-being, as well-being depends not only on the level of activity but also on the composition of it (due to consumption, investment, and government spending). In their model of the economy, monetary policy is the best response, and if it is sufficient to stop the recession, government spending ought to move in the same direction as private spending. If monetary policy is insufficient or restricted, fiscal policy should try to replicate what monetary policy would do. If that option, too, is restricted, conventional policies that increase government spending are merited. Key concepts include: The goal of this paper is to address this set of issues in light of modern macroeconomic theory. Unlike traditional Keynesian analysis of fiscal policy, modern macro theory begins with the preferences and constraints facing households and firms and builds from there. Policy is evaluated by how well it raises the welfare of households. Possible responses to consider, depending on the economic situation at hand, include a reduction of short-term interest rates by the central bank; a reduction in long-term interest rates; creating an investment tax credit or other incentives to entice interest-sensitive investors to spend; and, finally, a package of increased government spending and tax cuts to encourage consumption. The specific policy conclusions are based on a deliberately simple model, designed to clarify thinking rather than act as a prescriptive solution. Closed for comment; 0 Comments.