1. Robert Moffitt Johns Hopkins University
Brewer, Saez, and Shephard, “Optimal Household Labor Income Tax and Transfer Programs”
Robert Moffitt
Johns Hopkins University

2. Summary of the Paper Goals:
To review the UK tax and transfer system (MTRs, ATRs, etc)
To review recent developments in optimal tax theory
To propose a tax reform plan for the UK

3. Review of UK tax/transfer system
Computes MTRs and ATRs including all transfer, tax credit, positive tax, etc programs, including NI
Finds very high (100%) MTRs at bottom because of phaseout of income support
E.g., up to £3000 for one-earner couple with two children
MTRs and ATRs fall a bit at the 16-hour/week introduction of the WFTC

4. But MTRs remain high in the middle range
E.g., over 70% for the one-earner couple, up to £28,000 due to phaseout of the many means-tested tax credits, beginning of the positive tax system, etc.
Above that, MTRs fall to 40% and then below 40%
See figure

6. Any reasonable person would regard these as very high
Exact MTRs and location of the ranges vary with different household structures
Historically, top rate in the UK has fallen, but introduction of means-tested transfers (mainly refundable tax credits) has raised the MTR in the middle range
Positive tax system is individual-based, transfer/credit system is family/joint based

7. Optimal Tax Theory
Simple exposition of the Mirrlees model, tradeoff between desire for redistribution and labor supply disincentives
Result that MTR as the bottom is positive can be reversed if allow responses at the extensive rather than the intensive margin (i.e., can get earnings subsidies)
Assumes some labor supply elasticities, redistributional preferences, does some sims

9. Other issues:
International migration
Joint vs individual taxation
Collective model
Marriage and fertility responses
Administrative issues (problems with the WFTC)

10. Reform Plan
“Family allowance”: different guarantees (G) for different household structures (e.g., £9000 for couple with two children)
Phaseout at 45% MTR (individual, not joint, based)
Integrate the positive tax system to start right when Family allowance ends, start at 45% MTR

11. Pay for it by increasing other MTRs: eliminate the 10% bracket and start with 25%; increase 22% to 25%; keep 40%; have a new 46% bracket; and increase NI taxes
Administration: have all benefits paid on the same periodicity as the paycheck (weekly, monthly); update all incomes and household structures at same periodicity

12. Hilary Hoynes comments
US, UK, and some other countries have shifted toward in-work, earnings subsidy, work requirement, and other programs
Does this represent a change in the nature of the government's preference function? E.g., a preference that income be earned rather than unearned?
If not,what explains this shift?

13. Labor supply elasticities vary by marital status, number of children, and skill level/wage: how does this affect the optimal program?
Surprising that optimal system is individual rather than joint; how much of this is due to the assumptions? (one-earner vs two-earner, intensive vs extensive,etc)
Not enough attention paid to elasticities at the top
Reform plan just looks like a reduced taper and some harmonization. Anything else? In-work programs?

14. Moffitt Comments Good things about the paper:
Nice, simple, intuitive explanation of the Mirrlees model
(but Mirrlees (1971) was pretty good, too!)
(but no discussion of the Mirrlees results on the top rate of zero, or the subsequent literature's discussion of that
result)
Willing to stick its neck out on a reform plan

15. Some Minor Issues
No review of the (large) literature on optimal tax models since Mirrlees; but maybe this is not the right paper for that
Bringing in some international evidence on labor supply and household structure elasticities wouldn’t hurt
Paper is still in draft/rough form, will be cleaned up

16. Elasticities at the top
Agree with Hoynes, a huge issue
Started with Feldstein (1985): very high elasticities at the top, on the W margin as well as H margin
Even if elasticities are half of what he estimated, they are big; tail may wag the dog
Obvious implications for the authors’ reform plan

17. The Reform Plan
Looks like a simple NIT idea: lower the MTR, raise MTRs on the higher up taxpayers
This type of reform has gone out of style in the US
Maybe different in UK and Europe, where t’s are still high; but so are G’s (US: both G’s and t’s are low); makes it expensive to lower t

18. Changes in Government Preferences?
Agree with Hoynes on the question
There is a literature on this; e.g. Moffitt (EJ, 2006) adds ‘work’ per se to the government preference function, generates earnings subsidies as well as work requirements, etc
Is a literature: Besley-Coate, Blackorby, Cuff, et al. (some welfarist, some non-welfarist government preference fns)

19. Categorization
Perhaps of some interest to note that US has cut the Gordian knot of how to keep high G with low t by simply eliminating G for many groups
G>0 only for those with special needs (disabled, elderly, unemployed, single parents with young children); rest have G=0
Means you can afford an EITC because G=0 for most of those recipients

20. There is a model for this: Akerlof tagging model (Diamond, too)
Have i=1,…,N observable groups; each has a different weight in the SWF; give a different G and t to each, optimize over them; allow for efficiency losses from incentives to change group; allow for errors
Akerlof: get an increase in social welfare (reduce G on the less needy, work-able groups, increase it for the more needy, less-work-able)
Inevitable that SW rises: government has an additional tool