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Using a Microeconometric Model of Household Labour Supply to Design Optimal Income Taxes

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  • Rolf Aaberge
  • Ugo Colombino

Abstract

The purpose of this paper is to present an exercise where we identify optimal income tax rules according to various social welfare criteria, keeping fixed the total net tax revenue. Empirical applications of optimal taxation theory have typically adopted analytical expressions for the optimal taxes and then imputed numerical values to their parameters by using "calibration" procedures or previous econometric estimates. Besides the restrictiveness of the assumptions needed to obtain analytical solutions to the optimal taxation problem, a shortcoming of that procedure is the possible inconsistency between the theoretical assumptions and the assumptions implicit in the empirical evidence. In this paper we follow a different procedure, based on a computational approach to the optimal taxation problem. To this end, we estimate a microeconomic model with 78 parameters that capture heterogeneity in consumption-leisure preferences for singles and couples as well as in job opportunities across individuals based on detailed Norwegian household data for 1994. For any given tax rule, the estimated model can be used to simulate the labour supply choices made by single individuals and couples. Those choices are therefore generated by preferences and opportunities that vary across the decision units. We then identify optimal tax rules – within a class of 9-parameter piece-wise linear rules - by iteratively running the model until a given social welfare function attains its maximum under the constraint of keeping constant the total net tax revenue. The parameters to be determined are an exemption level, four marginal tax rates, three "kink points" and a lump sum transfer that can be positive (benefit) or negative (tax). We explore a variety of social welfare functions with differing degree of inequality aversion. All the social welfare functions imply monotonically increasing marginal tax rates. When compared with the current (1994) tax systems, the optimal rule
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  • Rolf Aaberge & Ugo Colombino, 2013. "Using a Microeconometric Model of Household Labour Supply to Design Optimal Income Taxes," Scandinavian Journal of Economics, Wiley Blackwell, vol. 115(2), pages 449-475, April.
    • Handle: RePEc:bla:scandj:v:115:y:2013:i:2:p:449-475
    DOI: sjoe.12015
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    1. Porath Elchanan Ben & Gilboa Itzhak, 1994. "Linear Measures, the Gini Index, and The Income-Equality Trade-off," Journal of Economic Theory, Elsevier, vol. 64(2), pages 443-467, December.
    2. O'Donoghue, Cathal & Colombino, Ugo & Narazani, Edlira & Locatelli, Marilena & Shima, Isilda, 2008. "Behavioural and welfare effects of basic income policies: a simulation for European countries," EUROMOD Working Papers EM5/08, EUROMOD at the Institute for Social and Economic Research.
    3. Knut Røed & Steinar Strøm, 2002. "Progressive Taxes and the Labour Market: Is the Trade–off Between Equality and Efficiency Inevitable?," Journal of Economic Surveys, Wiley Blackwell, vol. 16(1), pages 77-110, February.
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    Cited by:

    1. Decoster, André & Capéau, Bart, 2016. "Getting tired of work, or re-tiring in absence of decent job opportunities? Some insights from an estimated Random Utility/Random Opportunity model on Belgian data," EUROMOD Working Papers EM4/16, EUROMOD at the Institute for Social and Economic Research.
    2. Doerrenberg, Philipp & Duncan, Denvil, 2014. "Experimental evidence on the relationship between tax evasion opportunities and labor supply," European Economic Review, Elsevier, vol. 68(C), pages 48-70.
    3. Morini, Matteo & Pellegrino, Simone, 2018. "Personal income tax reforms: A genetic algorithm approach," European Journal of Operational Research, Elsevier, vol. 264(3), pages 994-1004.
    4. Matteo Picchio & Giacomo Valletta, 2018. "A welfare evaluation of the 1986 tax reform for married couples in the United States," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(3), pages 757-807, June.
    5. Islam, Nizamul & Colombino, Ugo, 2018. "The case for NIT+FT in Europe. An empirical optimal taxation exercise," Economic Modelling, Elsevier, vol. 75(C), pages 38-69.
    6. Julia Tanndal & Daniel Waldenström, 2018. "Does Financial Deregulation Boost Top Incomes? Evidence from the Big Bang," Economica, London School of Economics and Political Science, vol. 85(338), pages 232-265, April.
    7. Colombino Ugo, 2012. "A microeconometric-computational approach to empirical optimal taxation: outline of a project," Department of Economics and Statistics Cognetti de Martiis. Working Papers 201218, University of Turin.
    8. Vandyck, Toon & Van Regemorter, Denise, 2014. "Distributional and regional economic impact of energy taxes in Belgium," Energy Policy, Elsevier, vol. 72(C), pages 190-203.
    9. Dolls, Mathias & Peichl, Andreas & Zimmermann, Klaus F., 2011. "Eine Herausforderung für die G20: Global vereinbarte Schuldenbremsen und transnationale fiskalpolitische Aufsichtsgremien," IZA Standpunkte 45, Institute of Labor Economics (IZA).
    10. Thor O. Thoresen & Zhiyang Jia & Peter J. Lambert, 2016. "Is there More Redistribution Now? A Review of Methods for Evaluating Tax Redistributional Effects," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 72(3), pages 302-333, September.

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    More about this item

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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