1. Structure of the personal income tax

2. Introduction Personal income taxation is a fairly recent innovation
U.S. began in 1913
France 1914
Italy 1974 (before a plurality of taxes on income)
Generally the largest revenue-producing machine
45% of tax revenues in the U.S.
2° in France (after VAT)
1° in Italy (39% of total tax revenues)
Everywhere tax with largest number of (statutory) taxpayers

3. General structure
Income from taxable sources – deductions/exemptions = tax base or taxable income
Tax base * tax rate = tax liability before credits (aka gross tax liability)
Tax liability b. c. – detractions/credits = regular tax liability (aka net tax liability)
If net tax liability is negative → tax refund
If there is withholding at source (e.g., employee salaries, capital gains through bank funds) → tax due is difference between accumulated withholding payments and regular tax liability
In some countries (e.g. France) the tax authorities, not the citizens, prepare the tax declarations → taxpayer either accepts or must demonstrate that his/her tax liabilities are lower (e.g. frais réels)

4. Defining income
3 alternative definitions → different countries lean more towards one or the other (especially 1 and 2)
Produced income (De Viti De Marco) → all compensations from working activities
Y from K and L are taxed, but gifts and net additions to wealth (=savings) are not → controversial point
Revenue income (Haig and Simons)
Taxable income is money value of net increase in an individual’s power to consume during a certain period
Equal to consumption + savings (=potential consumption)
Problem: when to tax net additions to wealth? Usually when they are realized
Consumption income (Einaudi and Kaldor)
Tax base is annual consumption → all incomes - savings
Savings are not taxed
K gains taxed when realized → when they can finance consumption

5. What falls inside Haig-Simons (U.S.)
Wages and salaries
Business profits
Rents
Royalties
Dividends and interest receipts
Employer pension contributions and insurance purchases (→ increase potential to consume)
SS retirement benefits, transfers, unemployment compensation, welfare
Capital gains (realized or not; see above)
Income in kind and imputed rents (=rental value of owning the house)

6. Problems with Haig-Simons
Only income net of costs incurred to produce are subject to taxation → only increase in potential taxation is taxed
What about a party where clients are invited?
Not all assets have markets (e.g. what is the annual change of value of a particular Van Gogh?)
Imputed income from durables (e.g. house, cars) is difficult to measure
In-kind services not easy to value
What about housework?

7. What falls inside income produced (e.g. Italy)
Income from land property (estimated at cadastral value)
K income (dividends and interests received)
Salaries (Y when employed)
75% of total personal income tax revenues in Italy
Income from self-employed jobs (e.g. lawyers, retailers) → measured as difference between revenues and costs
Income from business activities (non corporate firms)
Others (e.g. sale of houses)

8. Equity and efficiency of H-S
All incomes are included → in line with horizontal equity
Different abilities (HK) not considered → violation
Efficiency → H.S aims at neutrality → all income sources taxed at same rate
Not efficient → different elasticities!
Yet it minimizes administrative costs

9. Excludable forms of money income
Interest on non-federal bonds
K gains (taxed at different rate, 15% if asset held for more than 1 year)
Inconsistent with H-S but aimed at stimulating investment in risky assets
Employer’s contributions to benefit plans
Some types of savings (e.g. education plans)
Gifts and inheritances
Separate taxation (WT)

10. Exemptions and deductions - 1
Exemptions for dependent children
In some countries a fixed sum (France and U.S.)
In others phased out with income level (Italy)
Raising children involves nondiscretionary expenses → taxable income should be adjusted accordingly
Exemptions are also a tax relief for low income families → taxable income gets abated
The greater the exemption → the greater is tax progressivity
The greater the marginal tax rate → the greater the value of a deduction of a given sum → the high tax rate does not apply to that sum
Tax credits (=subtraction from tax liability, not taxable income) are independent from marginal tax rates → do not affect tax progressivity as much as deductions

11. Exemptions and deductions - 2
Deductions can be of 2 kinds
Itemized → for specific expenditures (e.g. non reimbursed medical expenses, local income and property taxes, charitable contributions)
Non itemized (aka standard) → fixed amount that requires no documentation
Usually taxpayers must choose either one
Often the definition of deductions is controversial (e.g. donation to public museum is charitable, to a private not) → major source of complexity and obscurity in the tax

12. Rate structures - history
Tax rates are often subject to change
The Italian IRPEF was born with 32 brackets/rates, now it is down to 5 (used to be 4)
Top rate was 82%, now 43%
In 1913, personal income tax rates in the U.S. were between 1% and 7%
After WWII they went up to 23%-94%, in 1985 they were still 14 brackets, with rates between 11% and 50%
TRA86 created only 2 brackets, with top statutory rate of 28% → radical reform
As time goes by, tax systems, included tax rates schedules, tend to become more and more complex → political economy of taxation

13. Rate schedule in the U.S. Single return - taxable income Tax rate %
Joint return -
0-8350 10 15 25 28 33
>372951 35
Data for FY 2009

14. Rate schedule in Italy Tax bracket Statutory tax rate % <15.000 23 27 38 41
>75.000 43

15. Taxes and inflation 3 possible solutions
Inflation affects real tax liabilities if
Personal exemptions
Standard deductions
Tax brackets (bracket creep or fiscal drag)
Taxable interest/capital income
As inflation reduces the real value of nominal quantities → effective tax rates on these nominal quantities increase
3 possible solutions
Indexing (U.S.)
Ad hoc compensations (Italy)
Doing nothing → Leviathan government obtains (possibly) more revenues without giving the impression it has deliberately increased tax pressure

16. Choice of taxable unit 2 alternative solutions:
Taxing individuals separately on their own income
Taxing individuals who live together in a family on their joint incomes
Different tax liabilities can emerge even if their family income are the same
Example of tax system:
Taxable unit pays 10% on income up to 6000
Then 50% for income in excess of 6000
If the taxable unit is the family → two families pay same taxes
If taxable unit is individual → families with more unequal distribution of income pay more taxes
Individual tax liabilities increase when people marry → ‘marriage tax’
That because of tax progressivity
A solution is ‘income splitting’ → divide family income by 2, regardless of individual earnings, and file an individual declaration if lower than joint declaration
Family quotas attribute weight to different members of the family → more complicated

17. Example of ‘marriage tax’
Individual
income
tax
Family tax with
individual filing
Joint
Zelda
1000
100
12200
30000
12600
Ivan
29000
12100
Rose
15000
5100
10200
Stephan

18. Discussion
Why family?
Taxing family income justified by economies of scale within the family
Fairer treatment of household work
Recognition of importance of a family (value judgement) → removal of tax obstacles
But family is becoming less stable and more difficult to identify
Not clear that there are as many economies of scale as before
Taxing individual income justified because individual is the ultimate unit/agent
Large differences across countries
Italy: individual income with family detractions
U.S. choice of the taxable unit with income splitting
France: family quotas

19. Incomes earned abroad
Principles of global income taxation (U.S., most OECD countries)
Host country has primary right to tax income earned within its boundaries
Citizen has a tax obligation to his native land, wherever he earns his income from
Usually tax paid abroad is a tax credit on tax liability due to the application of domestic tax rates on foreign income
Principle of territorial taxation (UK)
Individuals earning income in a foreign country owe taxes only to host country
Global system may produce higher tax liabilities (never lower) than territorial system → distortion of production decisions
Territorial system distorts the choice of where to work → distortions of residential decisions
Hard to say which EB is greater