The Dynamic Process of Tax Reform

The tax reform literature, pioneered by Guesnerie [1977], uses static models but views tax reform as a dynamic process, i.e., as a policy-maker implementing incremental reforms over time. This paper studies tax reform in a dynamic version of the Diamond-Mirrlees-Guesnerie model and focuses on a specific aspect of the dynamic process, namely, the implications for tax reform of agents leaving bequests. The main idea is that a tax reform in one period will affect bequests and therefore endowments, equilibrium, and welfare in subsequent periods. Thus, the process of tax reform cannot be analyzed as a sequence of static economies; instead, the economies are linked by bequests. The paper undertakes a tax reform analysis a la Guesnerie, but with an added focus on welfare improving reforms for each generation. Second-best Pareto optima are then characterized, and these conditions are compared to the static optimal tax formulae derived in the literature. In particular, the key Diamond-Mirrlees result that production efficiency is desirable at second-best optima no longer holds in the presence of (effective) restrictions on the taxation of private savings. Restrictions on government savings (including balanced budget restrictions), however, do not disturb the desirability of production efficiency. Finally, the effects of certain political constraints on the tax reform process are also considerDynamic tax reform, second-best Pareto optima, capital taxation

Taxing and Subsidising Charitable Contributions

This paper examines a model of charitable contributions in which there exist both warm-glow and public good motives for giving, but where the warm-glow motive is competitive in the sense that individuals evaluate their own contribution relative to that of their peers. In this setting, it is shown that tax-financed charitable contributions by the government completely crowd out private contributions as the competitive element of the warm-glow motive intensifies. This implies that the warm-glow assumption may not be the best way of explaining the empirical evidence on incomplete crowding out. It is also shown that the tax-deductibility of charitable contributions acts to strengthen the crowding-out effect, and that it can be optimal to tax charitable contributions.

On the Crowding-Out Effects of Tax-Financed Charitable Contributions by the Government

An important question in the literature on charitable contributions is the extent to which tax-financed contributions by the government crowd out private contributions. This paper examines a simple model of charitable contributions in which there exist both warm-glow and public good motives for giving, but where the warm-glow motive is competitive in the sense that individuals evaluate their own contribution relative to that of their peers. It is shown that the competitive element of the warm-glow motive may exacerbate or attenuate the crowding-out effect, depending upon certain preference and income parameters. However, as the warm-glow motive for giving becomes purely competitive, crowding out is exacerbated and is almost dollar-for-dollar.Charitable contributions, warm-glow, crowding out, public goods

Nonlinear Income Tax Reforms

This paper addresses questions of the following nature: under what conditions does a welfare-improving reform of a nonlinear income tax system necessitate a change in a particular agent's marginal tax rate or total tax burden? Our analysis is therefore a study in tax reform, rather than in optimal taxation. We consider a simple model with three types of agents (high-skill, middle-skill, and low-skill) who have preferences that are quasi-linear in labour. Under these assumptions and using our methodology, specific characteristics of the initial suboptimal tax system can be determined when all welfare-improving tax reforms require specified changes in a particular agent's tax treatment. Some other necessary features of the tax reform can also be determined. Thus, unlike many tax reform analyses in the literature, we are able to reach a number of clear-cut conclusions.tax reform; nonlinear income taxation.

A Tax Reform Analysis of the Laffer Argument

This paper shows that tax reform techniques are well-suited to an examination of the Laffer argument, i.e., the possibility that an increase in a tax rate may reduce tax revenues (and vice versa). Our methodology allows us to examine the Laffer argument directly, without deriving the Laffer curve, which in turn allows us to conduct the analysis in a very general setting. Despite the high level of generality, we are able to reach some clear conclusions that provide formal support for the established intuitions that the Laffer effect requires: (i) a 'high' labour-income tax rate, and (ii) a 'large' labour supply response to wage changes. The notions of 'high' and 'large' are made precise in our framework. The analysis also provides indirect support for the intuition that it is never optimal for a government to operate on the downward-sloping segment of the Laffer curve. Finally, we show that our methods provide a theoretical framework for an empirical investigation.Laffer argument, tax reform

Optimal Nonlinear Income Taxation with Learning-by-Doing

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates no longer apply. In particular, if the government cannot commit and skill-type information is revealed, it is optimal to distort the high-skill consumer's labour supply downwards through a positive marginal tax rate to relax the incentive-compatibility constraint. Alternatively, if the government cannot commit and skill-type information is concealed, it is optimal to distort the high-skill consumer's labour supply upwards to relax the incentive-compatibility constraint, but due to some other factors at work the high-skill consumer's marginal tax rate cannot be signed. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on labour supply and wages.Income taxation, learning-by-doing, commitment.

Optimal Dynamic Nonlinear Income Taxation under Loose Commitment

This paper examines an infinite-horizon model of dynamic nonlinear income taxation in which there exists a small probability that the government cannot commit to its future tax policy. In this "loose commitment" environment, we find that even a little uncertainty over whether the government can commit yields substantial effects on the optimal dynamic nonlinear income tax system. Under an empirically plausible parameterization, numerical simulations show that high-skill individuals must be subsidized in the short run, despite the government's redistributive objective, unless the probability of commitment is higher than 98%. Loose commitment also reverses the short-run welfare effects of changes in most model parameters. In particular, all individuals are worse-off, rather than better-off, in the short run when the proportion of high-skill individuals in the economy increases. Finally, our main findings remain qualitatively robust to a setting in which loose commitment is modelled as a Markov switching process.Dynamic Income Taxation, Loose Commitment

Optimal Nonlinear Income Taxation with Habit Formation

It has recently been shown that incorporating "keeping up with the Joneses" preferences into a prototypical two-ability-type optimal nonlinear taxation model leads to higher marginal income tax rates for both types of agents. Specifically, the high-skill type faces a positive marginal income tax rate, rather than zero as in the conventional case. In this paper, agents' utility functions are postulated to exhibit "habit formation in consumption" such that the prototypical two-ability-type optimal nonlinear taxation model becomes a dynamic analytical framework. We show that if the government can commit to its future fiscal policy, the presence of consumption habits does not affect the standard results on optimal marginal income tax rates. By contrast, if the government cannot pre-commit, the high-skill type will face a negative marginal income tax rate, whereas the effect of habit formation on the low-skill type's marginal tax rate is ambiguous.Income Taxation; Habit Formation; Commitment

Currency Crises and Macroeconomic Performance

This paper presents some theory and evidence on the implications of sudden currency depreciations for output and inflation. It identifies some of the characteristics shared by countries which have suffered falling output in the aftermath of a currency crisis, and it presents a small model which rationalises aspects of this common experience. The model is then used to derive the optimal monetary policy response to a crisis. A key result is that a currency crisis which coincides with a banking crisis is more likely to depress output and may call for an accommodating monetary policy.currency crises; monetary policy

Interactive robots in experimental biology

Interactive robots have the potential to revolutionise the study of social behaviour because they provide several methodological advances. In interactions with live animals, the behaviour of robots can be standardised, morphology and behaviour can be decoupled (so that different morphologies and behavioural strategies can be combined), behaviour can be manipulated in complex interaction sequences and models of behaviour can be embodied by the robot and thereby be tested. Furthermore, robots can be used as demonstrators in experiments on social learning. As we discuss here, the opportunities that robots create for new experimental approaches have far-reaching consequences for research in fields such as mate choice, cooperation, social learning, personality studies and collective behaviour. © 2011 Elsevier Ltd