Econ 208 Marek Kapicka Lecture 9 Taxation

Midterm in a week! I’ll post older midterms Some Multiple Choice questions 2 longer questions Similar to PS1, PS2, PS3, Q1-2 in Mid 2011, Q1-2 in Mid 2010 Know: competitive equilibrium: how to solve, what each step MEANS. Know: Pareto Optimum Today’s class will be included. Wednesday will not.

Where are we? 1. Introduction: A model with no Government 2. Government Policies 1. The Effects of Government Spending 2. Government Taxation and Government Debt

What To Read Read Today: DLS, Chapter 13.2,13.4 The Region, Minneapolis Fed: “European Vacation”, on the web Next time: The Washington Post:"Where does the Laffer curve bend? "

Today Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government Revenue 4) The effects on GDP

Data on US Taxation Federal Government Revenue

Data on US Taxation Average Marginal Income Taxes

Taxation Lump-Sum tax vs. Distortive tax Lump sum tax does not depend on the actions of the consumer With distortive taxation, the welfare theorems fail Competitive equilibrium is not Pareto optimal

Why Distortive Taxation? In reality, lump-sum tax is infeasible Lump sum means everyone pays the same amount but some people have no wealth If differences among people are taken into account then a distorting tax is the only possibility What are the effects of a flat tax on Labor Supply? Government Revenue? GDP? Capital Accumulation?

Where we are Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government Revenue 4) The effects on GDP

2) The Effects on Labor Supply An Example Utility of a household Household problem:

2) The Effects on Labor Supply Solution: Labor Supply decreases in the tax rate

The model and the data E. Prescott (2004). “Why Do Americans Work So Much More Than Europeans?

U.S. vs. France 1990’s: French productivity higher, but labor supply much lower GDP per person lower in France than in the USA 1970’s: French productivity lower, but labor supply slightly higher

Ohanian, Raffo, Rogerson: A more comprehensive study Compare all the OECD countries for period How much can we explain by taxes? Look for alternative explanations as well. Conclusion: Taxes are the most important factor behind changes in labor supply

Ohanian, Raffo, Rogerson: The data

Ohanian, Raffo, Rogerson: The Results

Ohanian, Raffo, Rogerson: Other Factors Compute a labor supply wedge: Our model predicts that the wedge is equal to the tax rate. What if other factors, outside of the model, affect it as well? Look at measure of employment protection, union density, unemployment benefit replacement rate, duration benefits

Ohanian, Raffo, Rogerson: Other Factors

3) The Effects on Tax Revenue Government’s Tax revenue Revenue is not linear in the tax rate! If tax rate increases, Tax per one unit of labor supply increases but labor supply decreases

Laffer Curve Government’s revenue against the tax rate t T 0% 100%

Empirical Evidence 1981 Reagan Tax Cuts Overall, tax revenues have decreased However, for the tope earners the tac cuts have raised collections Maximum tax rate: 70% 50% Increase in revenue from top (>200000) earners: 3% in % in % in 1984

4) The Effect on GDP Christina Romer/ David Romer Classify all tax changes into Endogenous tax changes: Spending driven tax changes Recession driven tax changes Exogenous tax changes Belief motivated tax cuts Deficit driven tax increases Only exogenous tax changes will identify the effect on GDP

A timeline of tax changes

Exogenous tax changes

Endogenous tax changes

A response to a tax increase of 1% of GDP

Main result Tax increases have large negative effects on output/ labor supply