Tuesday, May 11, 2010

How to remove tax distortions with revenue neutrality

We all know that tax are usually bad because they distort, and this distortion goes the wrong way for most taxes. But we need them because the government needs some revenue, and some redistribution is fair. In the current context of high fiscal deficits, it would come in real handy if there were a way to overcome these distortions so that economic activity not be hampered by the inevitable increases in taxes. Proposals usually come from luminaries with dubious credentials, but when three established economists come to the rescue, you listen.

OK, I may be overdoing it, but Marco Del Negro, Fabrizio Perri and Fabiano Schivardi have an interesting proposal. The idea is to allow people to buy out future income taxes with a lump-sum payment. This is revenue neutral and removes the distortion, thus increasing the labor supply and then consumption and income. Things are not as simple as they seem. Indeed, the government does not know your ability to generate income ins the future. But it may elicit you to tell the truth by sharing some of the surplus created by the removal of the distortion. Concretely, the government offers a menu of contracts, which all contain a buyout price and a tax reduction, and people self-select optimally by potential income category.

As an example, they propose a $4500 buyout that reduces taxes by 5%. 10% of the population would buy this contract, which seems trivial yet increases GDP by 1%, because it is mostly the high income people ho take advantage of it. And this is Pareto improving. It is easy to see why: I can offer the government the same tax payment I would pay if I were under a proportional or progressive income tax against the ability to work as much as I want without tax consequences. Of course my labor supply will increase, I will earn more, spend more and other will have more income as a consequence and pay more taxes. Everybody wins. Where do I sign up?


Barkley Rosser said...

I thought that policy discussions were beneath you, E.L.

Agent Continuum said...

So, Prof. Rosser, how much are you enjoying being an online bully right now?

Why would you spend your afternoon harassing an anonymous blogger because (1) he had unflattering comments about one of your papers; (2) has some supporters on EJMR; and (3) won't reply to your email? Those all sound like really bad reasons to me.

rosserjb@jmu.edu said...

"Agent Continuum," I think we shall downgrade you to being merely "Corporal Countable Infinity." Yeah, I know, terrible online bullying of poor innocent anonymous bloggers. Shame on me.

Sawyer said...
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m3 zero said...
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