Designing Taxes for Raising Revenue Efficiently and Equitably By James A Mirrlees

Designing Taxes Taxes are introduced to obtain government revenue, but it matters who pays. People with higher income and wealth should pay more. Taxes are introduced to obtain government revenue, but it matters who pays. People with higher income and wealth should pay more. Taxes also affect what people do. They affect the amount and quality of labour people supply, they affect the supply of capital, and they affect patterns of consumption. The impact of a tax change on revenue is therefore not simple to estimate. Taxes also affect what people do. They affect the amount and quality of labour people supply, they affect the supply of capital, and they affect patterns of consumption. The impact of a tax change on revenue is therefore not simple to estimate.

The tax system should be designed to raise the desired revenue in such a way as to reduce the welfare of consumers as little as possible. The tax system should be designed to raise the desired revenue in such a way as to reduce the welfare of consumers as little as possible. Therefore you need to assess the relative importance of welfare gains and losses of people with different incomes and family circumstances. Therefore you need to assess the relative importance of welfare gains and losses of people with different incomes and family circumstances. But a surprising number of recommendations can be made without strong commitment to a particular way of assessing the welfare effects. But a surprising number of recommendations can be made without strong commitment to a particular way of assessing the welfare effects.

Equivalence of Tax Systems Apparently different tax systems can be effectively the same. Apparently different tax systems can be effectively the same. Ignore for the moment movement of people in and out of the economy. Then a tax at a uniform rate on all goods and services sold to consumers has the same effect as a tax on earnings at a uniform rate. The only difference is the level of prices and wages. Ignore for the moment movement of people in and out of the economy. Then a tax at a uniform rate on all goods and services sold to consumers has the same effect as a tax on earnings at a uniform rate. The only difference is the level of prices and wages. Therefore, to a first approximation, any debate between an (earned) income tax and a sales tax is empty. Therefore, to a first approximation, any debate between an (earned) income tax and a sales tax is empty.

Minor Differences There are some differences in the real world. There are some differences in the real world. Administrative costs are different. Probably smaller for the income tax. Administrative costs are different. Probably smaller for the income tax. Visitors pay the sales tax, not the income tax. Travellers abroad pay the income tax, not the sales tax on consumption while away. Visitors pay the sales tax, not the income tax. Travellers abroad pay the income tax, not the sales tax on consumption while away. Evasion and avoidance are different. Evasion and avoidance are different.

Major Differences The income tax need not be uniform: different individuals generally pay a different proportion of income in tax. The income tax need not be uniform: different individuals generally pay a different proportion of income in tax. Commodity taxes can differentiate between consumption of different goods and services. Commodity taxes can differentiate between consumption of different goods and services. Both of these ways of differentiating can be valuable. Both of these ways of differentiating can be valuable.

Income Tax Schedules Two aspects of the tax schedule matter to the consumer: the total tax paid, and the marginal tax rate, the proportion of extra income that would be paid in tax. Two aspects of the tax schedule matter to the consumer: the total tax paid, and the marginal tax rate, the proportion of extra income that would be paid in tax. Tax paid reduces welfare, and increases labour supply (except that it encourages emigration). Tax paid reduces welfare, and increases labour supply (except that it encourages emigration). A higher marginal tax rate reduces labour supply; thus reducing tax revenue, and increases tax paid by people with yet higher incomes. A higher marginal tax rate reduces labour supply; thus reducing tax revenue, and increases tax paid by people with yet higher incomes. An optimal tax schedule takes account of both these effects. An optimal tax schedule takes account of both these effects.

Optimal schedules have been calculated under various assumptions. In almost all cases, marginal tax rates are found to be constant or falling for most incomes. Optimal schedules have been calculated under various assumptions. In almost all cases, marginal tax rates are found to be constant or falling for most incomes. For the highest incomes, marginal tax rates do not depend much on the total revenue to be raised, or on judgments about the relative welfare of rich and poor. For the highest incomes, marginal tax rates do not depend much on the total revenue to be raised, or on judgments about the relative welfare of rich and poor. Optimal marginal tax rates vary from 40% to 60%. These are rates for all taxes that vary with income, and should be compared with the total of taxes on income and expenditures in real economies. Optimal marginal tax rates vary from 40% to 60%. These are rates for all taxes that vary with income, and should be compared with the total of taxes on income and expenditures in real economies.

Family Size It has proved difficult to work out how taxation should depend on the family structure, such as the number of dependents, and long-term relationships between earners. It has proved difficult to work out how taxation should depend on the family structure, such as the number of dependents, and long-term relationships between earners. Broadly, one would expect a good economic system to subsidize people whose productivity is small – and children are the leading example. Broadly, one would expect a good economic system to subsidize people whose productivity is small – and children are the leading example. Therefore it may be appropriate to include children in a formula for adjusted family size, and base tax on income divided by adjusted family size. Therefore it may be appropriate to include children in a formula for adjusted family size, and base tax on income divided by adjusted family size.

Surely it is also appropriate to allow income- sharing among adults, and base tax on income after sharing. This generalizes allowing deduction of payments to charity; and implies a consistent treatment of gifts and inheritance. Surely it is also appropriate to allow income- sharing among adults, and base tax on income after sharing. This generalizes allowing deduction of payments to charity; and implies a consistent treatment of gifts and inheritance.

Commodity Taxes How much of the taxation should be done by taxing commodities? That depends on whether some commodities should be taxed more than others. How much of the taxation should be done by taxing commodities? That depends on whether some commodities should be taxed more than others. Some consumption is, or is believed to be, undesirably large, either because consumers do not appreciate the harm they do to themselves, or because it harms others. Taxation of these commodities does good, and also raises revenue. Some consumption is, or is believed to be, undesirably large, either because consumers do not appreciate the harm they do to themselves, or because it harms others. Taxation of these commodities does good, and also raises revenue.

Tobacco, and, more doubtfully, alcohol and gambling are examples of the first. Taxes to reduce road use (by making petrol expensive), and taxes on the use of fossil fuels, to reduce global warming, are examples of the second. In total these can provide a substantial part of a government’s revenues. Tobacco, and, more doubtfully, alcohol and gambling are examples of the first. Taxes to reduce road use (by making petrol expensive), and taxes on the use of fossil fuels, to reduce global warming, are examples of the second. In total these can provide a substantial part of a government’s revenues.

Apart from these considerations, producer goods should not be taxed. Taxing goods sold by one producer (or importer) to another creates inefficiency. Apart from these considerations, producer goods should not be taxed. Taxing goods sold by one producer (or importer) to another creates inefficiency. There are reasons for taxing some consumer goods more than others. The main one is that goods that use more time in consumption should, ideally, be taxed more heavily; or equivalently, time-saving consumption could be subsidized. It encourages labour supply, and increases general tax revenue. There are reasons for taxing some consumer goods more than others. The main one is that goods that use more time in consumption should, ideally, be taxed more heavily; or equivalently, time-saving consumption could be subsidized. It encourages labour supply, and increases general tax revenue.

Housing Many countries have substantial taxation of housing. Many also provide some subsidised housing. Is this justified? Many countries have substantial taxation of housing. Many also provide some subsidised housing. Is this justified? It is hard to believe that housing provides many externalities, or involves consumption more meritorious than people realize. No doubt consumption of housing requires time, not all of it in competition with labour. But time-use per dollar is not particularly high. It is difficult to see a rationale for the relatively high taxation of housing that is a normal feature of tax systems. It is hard to believe that housing provides many externalities, or involves consumption more meritorious than people realize. No doubt consumption of housing requires time, not all of it in competition with labour. But time-use per dollar is not particularly high. It is difficult to see a rationale for the relatively high taxation of housing that is a normal feature of tax systems.

Saving and Taxes These principles can be used to see whether income from savings should be taxed. If you save now in order to consume more in future, and pay tax on the savings, that is an extra tax on future consumption. If that future consumption is in retirement, it does not use time that might have been used to supply labour. So it would be better to subsidize it. These principles can be used to see whether income from savings should be taxed. If you save now in order to consume more in future, and pay tax on the savings, that is an extra tax on future consumption. If that future consumption is in retirement, it does not use time that might have been used to supply labour. So it would be better to subsidize it. This is a rationale for not taxing savings that are to be used for retirement. This is a rationale for not taxing savings that are to be used for retirement.

But for the rich, much of the return to capital, though it appears as income from capital, is in fact a return to labour, and should be taxed as such; or it is the result of good luck, and might as well be taxed without any adverse incentive effects. But for the rich, much of the return to capital, though it appears as income from capital, is in fact a return to labour, and should be taxed as such; or it is the result of good luck, and might as well be taxed without any adverse incentive effects. Perhaps a good form of taxation would be one on excess returns, that is on capital income (including capital gains) less an ordinary return, measured by some suitable base rate of interest. Perhaps a good form of taxation would be one on excess returns, that is on capital income (including capital gains) less an ordinary return, measured by some suitable base rate of interest. Mobility of capital should be considered, but some loss of capital can be accepted for the sake of the tax revenue raised. Mobility of capital should be considered, but some loss of capital can be accepted for the sake of the tax revenue raised.