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Pareto-Improving Tax Reforms and the Earned Income Tax Credit

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  • Felix Bierbrauer
  • Pierre C. Boyer
  • Emanuel Hansen

Abstract

We develop a new approach for the identification of Pareto-improving tax reforms. This approach yields necessary and sufficient conditions for the existence of Pareto-improving reform directions. A main insight is that “Two brackets are enough”: When the system cannot be improved by altering tax rates in one or two income brackets, then there is no continuous reform direction that is Pareto-improving. We also show how to check whether a given tax reform is Pareto-improving. We use these tools to study the introduction of the Earned Income Tax Credit (EITC) in the US in 1975. A robust finding is that, prior to the EITC, the US tax-transfer system was not Pareto-efficient. Under plausible assumptions about behavioral responses, the 1975 reform was not Pareto-improving. Qualitatively, though, it had the right properties: A similar reform with earnings subsidies made available to a broader range of incomes would have been Pareto-improving.

Suggested Citation

  • Felix Bierbrauer & Pierre C. Boyer & Emanuel Hansen, 2020. "Pareto-Improving Tax Reforms and the Earned Income Tax Credit," CESifo Working Paper Series 8358, CESifo.
    • Handle: RePEc:ces:ceswps:_8358
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    5. Marcus Berliant & Pierre C. Boyer, 2024. "Politics and income taxes: Progress and progressivity," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 26(4), August.
    6. Isaak, Niklas & Jessen, Robin, 2024. "Normative judgments implicit in the tax system: A simulation approach," Ruhr Economic Papers 1128, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    7. Felix J Bierbrauer & Pierre C Boyer & Emanuel Hansen & Adrien Vallette, 2024. "Quelles possibilités d’autofinancement des réformes de la prime d’activité ?," Working Papers halshs-04563052, HAL.
    8. Koehne, Sebastian & Sachs, Dominik, 2022. "Pareto-improving reforms of tax deductions," European Economic Review, Elsevier, vol. 148(C).
    9. Hansen, Emanuel, 2021. "Optimal income taxation with labor supply responses at two margins: When is an Earned Income Tax Credit optimal?," Journal of Public Economics, Elsevier, vol. 195(C).
    10. Raghda Abdellatif Abdelkhalik Elsayed, 2023. "The impact of ontology-based knowledge management on improving tax accounting procedures and reducing tax risks," Future Business Journal, Springer, vol. 9(1), pages 1-18, December.
    11. Bierbrauer, Felix & Boyer, Pierre & Peichl, Andreas & Weishaar, Daniel, 2023. "The taxation of couples," CEPR Discussion Papers 18138, C.E.P.R. Discussion Papers.
    12. Felix Bierbrauer & Pierre Boyer & Emanuel Hansen, 2023. "Fantastic tax cuts and where to find them," ECONtribute Policy Brief Series 051, University of Bonn and University of Cologne, Germany.
    13. Laurence Jacquet & Etienne Lehmann, "undated". "Production Regulation Principles and Tax Reforms," THEMA Working Papers 2025-03, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    14. Schlee, Edward E. & Ali Khan, M., 2023. "Money-metrics in local welfare analysis: Pareto improvements and equity considerations," Journal of Economic Theory, Elsevier, vol. 213(C).
    15. Felix J Bierbrauer & Pierre C Boyer & Emanuel Hansen & Adrien Vallette, 2024. "On the design of self-financed Prime d’Activité reforms," Institut des Politiques Publiques halshs-04563073, HAL.
    16. Emanuel Hansen, 2020. "Optimal Income Taxation with Labor Supply Responses at Two Margins: When Is an Earned Income Tax Credit Optimal?," CESifo Working Paper Series 8630, CESifo.
    17. Schulz, Karl & Tsyvinski, Aleh & Werquin, Nicolas, 2023. "Generalized compensation principle," Theoretical Economics, Econometric Society, vol. 18(4), November.
    18. Xavier Dufour-Simard & Pierre-Carl Michaud & Michael Smart, 2025. "Is the elasticity of taxable income mostly an income effect?," Cahiers de recherche / Working Papers 04, Chaire de recherche Jacques-Parizeau en politiques économiques / Jacques-Parizeau Research Chair in Economic Policy.
    19. Xavier Dufour-Simard & Pierre-Carl Michaud & Michael Smart, 2025. "Is the elasticity of taxable income mostly an income effect ?," CIRANO Working Papers 2025s-05, CIRANO.

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    More about this item

    Keywords

    tax reforms; non-linear income taxation; optimal taxation; earned income tax credits; Pareto efficiency;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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