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Malas notches

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  • Ben Lockwood

    (University of Warwick)

Abstract

This paper shows that the sufficient statistic approach to the welfare properties of income (and other) taxes does not easily extend to tax systems with notches, because with notches, changes in bunching induced by changes in tax rates have a first-order effect on tax revenues. In an income tax setting, we show that the marginal excess burden (MEB) of a change in the top rate of tax is given by the Feldstein (Rev Econ Stat 81(4):674–680, 1999) formula for the MEB of a proportional tax, plus a correction term. This formula applies even if there is tax evasion. These correction terms cannot be calculated just from knowledge of the elasticity of taxable income, and quantitatively, they can be large. An application to VAT is discussed; with a calibration to UK data, the MEB of the VAT is roughly three times what it would be if VAT was simply a proportional tax.

Suggested Citation

  • Ben Lockwood, 2020. "Malas notches," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(4), pages 779-804, August.
    • Handle: RePEc:kap:itaxpf:v:27:y:2020:i:4:d:10.1007_s10797-020-09589-3
    DOI: 10.1007/s10797-020-09589-3
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    More about this item

    Keywords

    Tax kink; Tax notch; Excess burden; Sufficient statistic;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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