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Do Very High Tax Rates Induce Bunching? Implications for the Design of Income-Contingent Loan Schemes

  • Bruce Chapman

    ()

    (CEPR, RSSS, ANU)

  • Andrew Leigh

    ()

    (SPEAR Centre, RSSS, ANU)

We test whether very high marginal tax rates affect taxpayer behaviour, using a unique policy. Under the Higher Education Contribution Scheme – an income-related university loans scheme in Australia – former students with a debt face a sharp discontinuity. At the first repayment threshold they are required to repay a percentage of their entire income, resulting in an effective marginal tax rate that could be regarded as being as high as 76,000 percent. We formally model the taxpayer decision, and then use a sample of taxpayer returns provided to us by the tax office to investigate whether taxpayers bunch below the repayment threshold. We find a statistically significant degree of bunching below the threshold, but the effect is economically small. On net, we estimate that both the deadweight cost and the budgetary loss are less than A$1 million per year, a small fraction of the amount annually repaid through the Higher Education Contribution Scheme. The result has an important implication for the design of income contingent loans for higher education, such as those being introduced in the UK for tuition in September 2006. This is that it is possible to design arrangements in which the first income threshold of repayment is apparently high, but which are still able to deliver relatively high revenue streams in the early stages of income contingent policy reform without important tax payment avoidance consequences. Our findings also reinforce earlier research suggesting only minimal bunching around kink points in taxation schedules.

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File URL: https://www.cbe.anu.edu.au/researchpapers/cepr/DP521.pdf
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Paper provided by Centre for Economic Policy Research, Research School of Economics, Australian National University in its series CEPR Discussion Papers with number 521.

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Length: 30 pages
Date of creation: Apr 2006
Date of revision:
Handle: RePEc:auu:dpaper:521
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  1. Leora Friedberg, 2000. "The Labor Supply Effects of the Social Security Earnings Test," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 48-63, February.
  2. Richard Blundell & Hilary W. Hoynes, 2004. "Has 'In-Work' Benefit Reform Helped the Labor Market?," NBER Chapters, in: Seeking a Premier Economy: The Economic Effects of British Economic Reforms, 1980-2000, pages 411-460 National Bureau of Economic Research, Inc.
  3. Braithwaite, Valerie & Ahmed, Eliza, 2005. "A threat to tax morale: The case of Australian higher education policy," Journal of Economic Psychology, Elsevier, vol. 26(4), pages 523-540, August.
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