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Empirical Evidence and Tax Reform: Lessons from the Mirrlees Re Vie W Empirical Evidence and Tax Reform: Lessons from the Mirrlees Re vie w LtLecture 3: Consump tion and S avi ngs T axati on Munich Lectures in Economics 2010 CESifo November 18th 2010 Richard Blundell University College London and Institute for Fiscal Studies © Institute for Fiscal Studies Key Margins of Adjustment • Consumer demand responses – responses to differential taxation of across commodities • Savings-pension portfolio mix – ‘Life-cycle’ accumulation of savings and pension contributions • Forms of remuneration – CGT reforms and the non-alignment with labour income rates • Organisational form – UK chart on incorporations and tax reforms • Draw on evidence from the Tax by Design – 20 chapters by the editors – and Dimensions of Tax Design (MR1) – all free on the web! Dimensions of Tax Design: commissioned chapters and expert commentaries (1) • The base for direct taxation James Banks and Peter Diamond; Commentators: Robert Hall; John Kay; Pierre Pestieau • Means testing and tax rates on earnings Mike Brewer, Emmanuel Saez and Andrew Shephard; Commentators: Hilary Hoynes; Guy Laroque; Robert Moffitt • Value added tax and excises Ian Crawford, Michael Keen and Stephen Smith; Commentators: Richard Bird; Ian Dickson/David White; Jon Gruber • EiEnvironmen tlttital taxation Don Fullerton, Andrew Leicester and Stephen Smith; Commentators: Lawrence Goulder;;g Agnar Sandmo • Taxation of wealth and wealth transfers Robin Boadway, Emma Chamberlain and Carl Emmerson; Commentators: HlHelmut hCh Cremer; Thomas Piketty; Mart in Wea le Dimensions of Tax Design: commissioned chapters and expert commentaries (2) • International capital taxation Rachel Griffith, James Hines and Peter Birch Sørensen; Commentators: Julian Alworth; Roger Gordon and Jerry Hausman • Taxing corporate income Alan A uerb ach , Mike Devereux an d He len Simpson; CttCommentators: Harry Huizinga; Jack Mintz • Taxation of small businesses Claire Crawford and Judith Freedman • The effect of taxes on consumppgtion and saving Orazio Attanasio and Matthew Wakefield • Administration and compp,liance, Jonathan Shaw, Joel Slemrod and John Whiting; Commentators: John Hasseldine; Anne Redston; Richard Highfield • Political economy of tax reform , James Alt, Ian Preston and Luke Sibieta; Commentator: Guido Tabellini Consumer demand behaviour • Three key empirical observations: • Non-separabilities w ith la bour supp ly are impor tan t – but mainly for childcare and work related expenditures – updated evidence in the Review • Price elasticities differ with total expenditure/ wealth – resppponses and welfare impact differs across the distribution – new evidence shows compensation and welfare losses vary across the distribution • Issues around salience of indirect taxes – Chetty et al (AER) Savings and Pensions • When the life-cycle model works – How much life-cyypcle consumption/needs smoothing gg goes on? Net Income, Number of Equivalent Adults per Household 700 3.5 600 3 old old) 500 252.5 hh 400 2 er Househ Per House Per PP ss 300 1.5 Net Income Per lent Adult y Income ( 200 Hhld(LHAi)Household (LH Axis) 1 aa Equivalent AdultsPer Equiv Weekl 100 Household (RH Axis) 0.5 0 0 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 Age of Head Source: UK FES 1974-2006 Consumption and Needs 700 3.5 ee 600 Equivilised Non-Durable 3 Expenditure (LH Axis) penditur lt) Equivalent AdultsPer ts Per Per ts xx ll uu 500 2.5 Household (RH Axis) 400 2 Durable E alent Adu ehold ivalent Ad -- vv ss 300 1.5 Hou (Per Equ (Per r of Equi r ilised Non ilised 200 1 ee vv Numb Equi 100 0.5 0 0 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 AfHdAge of Head Source: UK FES 1974-2006 Savings and Pensions • How muc h life-cyclti/dthile consumption/needs smoothing goes on? • - permanent/ t ransit ory sh ock s t o i ncome across wealth distribution (Blundell, Pistaferri and Preston (AER)) • - consumption and savings at/f/after retirement (BBT ()(AER)) • - how well do individuals account for future changes? – UK pension reform announcements Attanasio & Rohwedder (AER) – Liebman, Luttmer & Seif (AER) • Intergeneration transfers - Altonji, Hayashi & Kotlikoff, etc – More recent evidence on bequests Savings and Pensions • Temporal preferences, ability, cognition, framing.. – Banks & Diamond (MRI chapter); Diamond & Spinnewijn, Saez,.. • Earnings/skill uncertainty – across life -cycle and business cycle – Role in dynamic fiscal policy arguments for capital taxation Kocherlakota; Golosov, Tsyvinski & Werning, .. Implications for Reform • Indirect Tax ation • Taxation of Savings • An integrated and revenue neutral analysis of reform… Two gggood broad guidelines for indirect taxation 1. Tax final consumption only • VAT generally achieves this • But stamp duties, business rates and VAT exemptions do not 2. Tax goods at the same rate • Complexity creates strong presumption against differentiation • There are sound economic efficiency arguments for differentiation • But case sufficiently strong in only a few cases ¾ Childcare, ‘sin taxes’‘ green taxes’ • Distributional arguments for differentiation are weaker © Institute for Fiscal Studies • Evidence on consumer behaviour => exceptions to uniformity – Childcare strongly complementary to paid work – Various work related expenditures (QUAIDS on FES, MRI) – Human capital expenditures – ‘Vices’: alcohol,,,g,pyy tobacco, betting, possibly unhealthy food have externality / merit good properties Î keep ‘sin taxes’ – Environmental externalities (three separate chapters in MRII) • These do not line up well with existing structure of taxes ⇒Broadening the base – many zero rates in UK VAT • Compensating losers, even on average, is difficult • Worry about work incentives too • Work with set of direct tax and benefit instruments as in earnings tax reforms Indirect Taxation – UK case Zero-rated: Estimated cost (£m) Food 11,300 Construction of new dwellings 8,200 Domestic passenger transport 2,500 ItInterna tiona lpassenger tttransport 150 Books, newspapers and magazines 1,700 Children’s clothing 1,350 Drugs aadnd medic ines on presc ript io n 1,350 Vehicles and other supplies to people with disabilities 350 Cycle helmets 10 Reduced-rated: DtiDomestic flfuel and power 2, 950 Contraceptives 10 Children’s car seats 5 Smoking cessation products 10 Residential conversions and renovations 150 VAT-exempt: Rent on domestic dwellings 3,500 RtRent on commercilial properties 200 Private education 300 Health services 900 Postal services 200 Burial and cremation 100 Finance and insurance 4,500 © Institute for Fiscal Studies Impact on budget share of labour supply Conditional on income and prices Bread and Cereals Negative Meat and Fish Negative Dairy products Negative Tea and coffee Negative Fruit and vegetables Negative Food eaten out Positive Beer Positive Wine and spirits Positive Domestic fuels Negative Household goods and services Positive Adult clothing Positive Childrens’ clothing Negative Petrol and diesel Positive Source: QUAIDS on UK FES, MRI VAT in the UK • UK zero-rates most food, water, reading matter, children’s clothes,… – Clearly for distributional, not efficiency, reasons Î shldbddhould be ended – Other countries show that it is not inevitable • Reduced rate on domestic fuel looks ppyarticularly bad given environmental concerns • Exemptions violate both of our principles © Institute for Fiscal Studies Implicit carbon taxes, 2009-10 Excluding VAT subsidy of domestic energy Coal-generated electricity, business Gas-generated electricity, business Gas for heating, business Coal-generated electricity, domestic Gas-generated electricity, domestic Gas for heating, domestic £0 £10 £20 £30 £40 £50 £/tonne CO2 © Institute for Fiscal Studies Broadening the VAT base • We simulate removing almost all zero and reduced rates • Raises £24bn (with a 17.5% VAT rate) if no behavioural response • Reduces distortion of spending patterns – With responses we find, could (in principle) compensate every household and have about £3-5bn welfare gain • On its own base broadening would be regressive and weaken work incentives • Can a pppgractical package avoid this? © Institute for Fiscal Studies We illustrate one way of using the money: • Automatic 3.4% indexation of all tax thresholds and benefit rates. Plus… • Extra 3.4% means-tested benefits, 2% state pension, 10% c hild bene fit • £1,000 increase in income tax allowances • £4,530 cut in income tax basic rate limit and NIC upper earnings limit • 2p cut in basic rate, 1½p cut in higher rate, of income tax © Institute for Fiscal Studies VAT ref orm: eff ect s b y i ncome % rise in non-housinggp expenditure % rise in income 8% 7% 6% 5% 4% 3% 2% 1% 0% Poorest 23456789Richest Income Decile Group © Institute for Fiscal Studies VAT ref orm: eff ect s b y expendit ure % rise in non-housing expenditure % rise in income cashi/l(£/kRHi)h gain/loss (£/week, RH axis) 8% £8 7% £6 6% £4 5% £2 4% £0 3% -£2 2% -£4 1% -£6 0% -£8 Poorest 23456789Richest Expenditure Decile Group © Institute for Fiscal Studies VAT reform: incentive to work at all Participation tax rates 5% 55 50% 45% 40% 35% 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 Employer cost (£/week) Before reform After reform © Institute for Fiscal Studies VAT reform: incentive to increase earnings Effective marginal tax rates 0% 66 55% 50% 45% 40% 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 Employer cost (£/week) Before reform After reform © Institute for Fiscal Studies Broadening the base of indirect taxation • Empirical results suggest current indirect tax rates do not line
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