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Taxation Research As Economic Research Taxation Research as Economic Research Paper number 01/07 Simon James University of Exeter Simon James, School of Business and Economics, University of Exeter, Streatham Court, Rennes Drive, Exeter, EX4 4PU, United Kingdom. Email: [email protected] Acknowledgements The author is grateful for comments on earlier versions from Alan Macnaughton, John Maloney and Claudio Radaelli, for comments on an earlier draft. 1 ISSN No: 1473 2939 2 1. Introduction Economics is concerned with the production and distribution of wealth. Taxation has either direct or indirect effects on almost every aspect of production and distribution in modern economies and is therefore an important aspect in economic research. Indeed taxation is associated with almost everything economic from globalisation (Owens, 1993) to divorce (Cebula and Belton, 1995). The result has been an enormous body of literature and all that can be attempted here is to indicate some of the main areas of research activity. The research ranges from highly technical and theoretical work to more practical economic analyses of policy questions. It includes theoretical contributions, econometric studies, interview surveys and some experimental work. In terms of interdisciplinary research, it is the policy area that has the most scope for successful work because it is here that an economic approach has the greatest opportunities to strengthen the research by drawing on other disciplines such as Accounting, Law, Psychology and Sociology. In Economics the main direct contribution to tax research is based in the general subject area of Public Finance. Taxation is therefore dealt with as a major part of general public finance texts such as Brown and Jackson (1990) and Cullis and Jones (1998). Atkinson and Stiglitz (1980) give an introduction to the subject at graduate level and a further technical treatment is supplied by Jha (1998). Tax is the specific focus of other textbooks. These include Kay and King (1990) who deal with the subject with reference to the British tax system and James and Nobes (2000) who offer a more general treatment. Although much of the emphasis in economics research relates to markets of one sort or another, it is widely agreed by economists that the public sector has important economic functions. Therefore a general theme in tax research is how the necessary tax revenue to support the public sector can be raised in the most efficient and equitable way. The next two sections of the paper deal with economic efficiency, Section 2 with respect to the allocation of resources and Section 3 with tax and incentives to work, save and invest. Section 4 turns to equity and the distribution of 3 income and Section 5 to macroeconomic considerations. Section 6 gives a brief account of experimental work in Economics. Section 7 turns to research focused on particular types of taxation and Section 8 to some specific areas of tax policy and reform. Finally there has been some criticism both inside and outside the profession that the contribution of economics to policy research may not always be as relevant as it might be and this is discussed briefly in Section 9. 2. Economic Efficiency and the Allocation of Resources. ‘He’s spending a year dead for tax reasons,’ wrote the science fiction writer Douglas Adams in The Restaurant at the End of the Universe. Generally, it is thought that if people do things for tax reasons, rather than because of the underlying economic costs and benefits, they are behaving inefficiently in economic terms even if they gain some personal financial advantage. While it is possible that people might in the future wish to spend time dead as a matter of personal choice, it is not economically efficient if they do so only to avoid taxation. Economic efficiency is about maximising economic output given the resources available to the community. This is not just maximising production but also producing the goods and services that consumers value most. It is possible to show that, in certain circumstances, markets are economically efficient. If a tax distorts an otherwise efficient market this is known as the excess burden of taxation. This is the extra economic cost imposed on the community because taxes have caused people to make economic decisions they would not otherwise have made. In the Douglas Adams case it would be the loss of one year of life given up to save tax. There are countless examples throughout an economy of distortionary behaviour caused by taxation and a great deal of economic tax research has been undertaken into the excess burden caused by different taxes in different circumstances (James and Nobes, 2000). Some of the economic research in this area is very technical but general conclusions can be drawn, subject to a number of limitations and exceptions. In efficient markets, taxes that have a wider base are less likely to create distortions than those with a 4 narrower base. Thus a tax on all goods and services is likely to be less distortionary than taxes on only a limited number of goods and services. Another conclusion relates to goods and services that are inelastic in demand or supply, in other words the amount bought and sold changes relatively little when the price changes. Higher taxes on such goods cause a relatively low fall in consumption and also, therefore, the level of tax revenue is more robust. Examples include the taxation of alcohol and tobacco. With inefficient markets, there may be scope to use taxation to guide economic behaviour in the right direction. For example, some economic activities, such as those causing pollution, impose costs on the wider community. It might be possible to assign such costs to the producers and consumers by imposing a special tax. The result has been the development of various forms of corrective taxation, including ‘pollution charges’, ‘green taxes’ and so on (Cordes, et al., 1990, Nicolaisen et al. 1991, Symonds, et al. Smith, 1992 and Oates, 1995). A particularly topical issue here is the debate regarding road congestion taxes (Newbery and Santos, 1999). There may be other costs to the consumers themselves and this has been used, for instance, as part of the justification for higher taxation on alcohol (Irving and Sims, 1993, Cook and Moore, 1994) and tobacco (Viscusi, 1994). 3. Economic Efficiency and Incentives Another very large part of tax research relating to economic efficiency is concerned with incentives, particularly the effects of taxation on the willingness of individuals to work, to save and to invest. The effects of taxation on work effort, or labour supply, has generated a huge amount of research. When an income tax is increased this reduces the net financial return to work and individuals might substitute other activities or leisure for paid employment - and this is known as the substitution effect. On the other hand, a tax increase would make individuals worse off and therefore that might make them work harder to maintain their incomes - the income effect. The overall effect of taxation on labour supply is therefore an empirical question and has been subject to a very large number of investigations. 5 Interviews asking individuals about the effects of taxation on their work effort might well be subject to bias of one sort or another. However, an early interview study by Break (1957) became something of a classic because of the care it took to avoid influencing the respondents. This study was replicated by Fields and Stanbury (1971) and similar studies have been conducted by Barlow et al. (1966) and others. There is also a considerable amount of econometric evidence largely based on the relationship between labour supply and net wages. Useful sources covering the material include Brown (1983) for a general overview, Pencavel (1986) with respect to the labour supply of men and Killingsworth and Heckman (1986) regarding female labour supply. A survey of the subject is presented by Blundell (1992). The main result of this work is the conclusion that in general taxation does not have much effect on the labour supply of most individuals. However, some econometric evidence has been taken to suggest that the effect of taxation on married women provides a significant disincentive to paid labour supply. For instance Killingsworth’s (1983: 432) survey found that ‘most of the available evidence suggests that female labour supply, measured either as labour force participation or as hours of work, is considerably more wage and property income elastic than male labour supply.’ This seems to be an example of an area where economic analysis and econometric studies can be enhanced by a multidisciplinary input. For instance there is psychological and sociological evidence that, despite many years of discussion about possible changes in gender roles, many women with children still see themselves primarily as care-givers, while their male partners still see themselves as ‘breadwinners’ (James et al., 1992, James, 1995). If women have difficulties in combining their family and paid work with current labour market practices this may affect econometric evidence of the effect of taxation on their labour market behaviour. Also, further econometric work which has tackled some of the problems of estimation has indicated that the effects of taxation on the paid employment of women is less than earlier work has suggested – see, for example Mroz (1987) and Blundell (1992). The effects of taxation on saving have also received a considerable amount of attention. Only through saving can economic resources be released for capital investment and the rate of saving can affect the level of economic activity by 6 influencing the aggregate level of demand. The tax system can make a substantial difference to the rate of return to saving. However it is not clear how far this adversely affects saving since different researchers have produced different results.
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