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Tax policy and the missing middle: Optimal tax remittance with firm-level administrative costs

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  • Dharmapala, Dhammika
  • Slemrod, Joel
  • Wilson, John Douglas

Abstract

We analyze the optimal taxation of firms when the government faces fixed (per-firm) administrative costs of tax collection. The tax instruments at the government's disposal are a fixed (per-firm) fee and a linear tax on output. If all firms in an industry are taxed, we show that it is optimal to impose a positive fee to internalize administrative costs. The output taxes satisfy the inverse elasticity rule for taxed industries, but industries with sufficiently high administrative costs should be exempted from taxation. We also investigate the case where firms with outputs below a cutoff level can be exempted from taxation. It may be optimal to set the cutoff high enough to exempt a sizable number of firms, even though some firms reduce their outputs to the cutoff level, creating a “missing middle”: small and large firms – but not those of intermediate size – exist. Thus, this common phenomenon in developing countries may result from optimal policies. The paper also presents a modified inverse-elasticity rule when output cutoffs are used, and it extends the analysis to include optimal nonlinear taxes on output.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 95 (2011)
Issue (Month): 9 ()
Pages: 1036-1047

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Handle: RePEc:eee:pubeco:v:95:y:2011:i:9:p:1036-1047

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Web page: http://www.elsevier.com/locate/inca/505578

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Keywords: Taxation; Optimal taxation; Administrative costs;

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Cited by:
  1. Timothy Besley & Torsten Persson, 2013. "Taxation and Development," STICERD - Economic Organisation and Public Policy Discussion Papers Series, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE 41, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  2. Christian Bauer & Ronald B Davies & Andreas Haufler, 2011. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Working Papers, School Of Economics, University College Dublin 201115, School Of Economics, University College Dublin.
  3. Gordon, Roger & Li, Wei, 2009. "Tax structures in developing countries: Many puzzles and a possible explanation," Journal of Public Economics, Elsevier, Elsevier, vol. 93(7-8), pages 855-866, August.
  4. Kumler, Todd J. & Verhoogen, Eric & Frias, Judith A., 2013. "Enlisting Employees in Improving Payroll-Tax Compliance: Evidence from Mexico," IZA Discussion Papers 7591, Institute for the Study of Labor (IZA).
  5. Kanbur, Ravi & Keen, Michael, 2014. "Threshold, Informality, and Partitions of Compliance," Working Papers, Cornell University, Department of Applied Economics and Management 180136, Cornell University, Department of Applied Economics and Management.
  6. Almunia, Miguel & Lopez-Rodriguez, David, 2012. "The efficiency cost of tax enforcement: evidence from a panel of spanish firms," MPRA Paper 44153, University Library of Munich, Germany.
  7. Henrik Jacobsen Kleven & Claus Thustrup Kreiner & Emmanuel Saez, 2009. "Why Can Modern Governments Tax So Much? An Agency Model of Firms as Fiscal Intermediaries," NBER Working Papers 15218, National Bureau of Economic Research, Inc.
  8. Sasan Bakhtiari, 2013. "Firm Size Evolution and Outsourcing," Discussion Papers, School of Economics, The University of New South Wales 2013-07, School of Economics, The University of New South Wales.

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