Public Economics: Tax & Transfer Policies

*(Master PPD, Paris School of Economics)*

Thomas Piketty

Academic year 2012-2013

**Syllabus & Course Material**

(October 23^{rd} 2012)* (check on line for updated versions)*

Email : piketty@ens.fr

Office hours: Tuesdays 9h-12h, Jourdan B101

Course web page : http://piketty.pse.ens.fr/teaching/10/18

Previous year syllabus : http://piketty.pse.ens.fr/teaching/10/43

The objective of this course is to present the basic tools and concepts of modern public economics, with special emphasis on the incidence of tax and transfer policies, both in developed countries (EU, US) and in the developing world.

The course is organized in 8 lectures of 3 hours. To validate the course, students are required (1) to attend and actively participate to all lectures; (2) to take the exam.

Lecture 1: Tuesday October 2^{nd} 2012, 14h-17h, Grande salle Jourdan

Lecture 2: Tuesday October 9^{th} 2012, 14h-17h, Grande salle Jourdan

Lecture 3: Tuesday October 16^{th} 2012, 14h-17h, Grande salle Jourdan

Lecture 4: Tuesday October 23^{rd} 2012, 14h-17h, Grande salle Jourdan

Lecture 5: Tuesday October 30^{th} 2012, 14h-17h, Grande salle Jourdan

Lecture 6: Tuesday November 6^{th} 2012, 14h-17h, Grande salle Jourdan

Lecture 7: Tuesday November 13^{th} 2012, 14h-17h, Grande salle Jourdan

Lecture 8/Exam: Tuesday November 20^{th} 2012, 14h-17h, Grande salle Jourdan

**General references**

P. Diamond & E. Saez, "The Case for a Progressive Tax: From Basic Research to Policy Recommendations", Journal of Economic Perspectives 2011

P. Lindert, Growing Public, Cambridge University Press, 2004

J. Mirrlees, Reforming the Tax System for the 21^{st} Century – The Mirrlees Review, Oxford University Press 2010-2012

T. Piketty & E. Saez, "Optimal Labor Income Taxation", 2012, forthcoming in Handbook of Public Economics, vol. 5

B. Salanié, Théorie économique de la fiscalité, Economica, 2002 (The Economics of Taxation, MIT Press, 2003)

C. Landais, T. Piketty & E. Saez, Pour une révolution fiscale - Un impôt sur le revenu pour le 21e siècle, Le Seuil, 2011, www.revolution-fiscale.fr

**Lecture 1. Taxes & Transfers: Why and How Much?**

Basic rationales for taxes and transfers:

(1) Public good provision: raising tax revenue to finance public goods

(2) Redistribution: designing taxes & transfers in order to implement a fair distribution of income, wealth and welfare

(3) Externalities: Pigouvian corrective tax and subsidy schemes so to induce private agents to internalize external effects (e.g. global warming, carbon tax)

(4) Stabilization: taxes & transfers can also serve as automatic stabilizers and reduce macroeconomic volatility (mostly a by-product of tax and transfer systems)

Rationales (1), (2), (4) = taxes/transfers generate Pareto improvements and correspond to failures of the first welfare theorem

Rationale (3) = taxes/transfers shift the economy to another (second-best) Pareto optimum (illusory lump-sum payments of the second welfare theorem)

Basic facts about taxes and transfers in rich countries:

Total taxes T = about 40% of national income Y

I.e. T = τY with τ = 40%

Total monetary transfers Y_{T} = about 15% of national income Y

(=pay-as-ou-go pensions, unemployment & family benefits, means-tested transfers,..)

Disposable household income Y_{D} = Y-T+Y_{T} = about 75% of national income Y

Other government spendings = about 25% of national income

Typically: 1/3 education + 1/3 health + 1/3 police, defense, roads, etc.

(=in-kind transfers)

(National income Y = GDP – capital depreciation + net foreign factor income)

(Typically Y = about 85%-90% GDP)

On structure of spendings, see Adema et al, OECD 2011; see also Piketty-Saez 2012 Table 1

On structure of taxes, see “Taxation Trends in the European Union”, Eurostat 2011; see also Selected Tables

Typically: T = 1/3 indirect taxes + 1/3 direct taxes + 1/3 social contributions

But: large variations across countries

And: this decomposition is not really meaningful; what matters is the factor income decomposition (capital vs labor) and the consumption vs saving decomposition

In poor countries: T = as low as 10%-15% of national income Y

See Cage-Gadenne 2012, "The Fiscal Cost of Trade Liberalization", Figure 3

**Lecture 2. Tax Incidence Through the Lenses of National Accounts**

Tax incidence problem = the central issue of public economics = who pays what?

General principle: it depends on the various elasticities of demand and supply on the relevant labor maket, capital market and goods market.

Usually the more elastic factor wins, i.e. shifts taxations towards the less elastic.

Opening up the black box of national accounts tax aggregates is a useful starting point in order to study factor incidence.

Basic equations:

National income = capital income + labor income = consumption + savings

Y = F(K,L) = Y_{K}+Y_{L }= C+S

Total taxes = capital taxes + labor taxes + consumption taxes

T = τY = T_{K}+T_{L}+T_{C} = τ_{K}Y_{K} + τ_{L}Y_{L} + τ_{C} C

[Implicit labor vs capital vs consumption tax rates in the EU (Eurostat estimates)]

Typically, τ_{L}=35%-40%, τ_{K}=25%-30%, τ_{C}=20%-25%.

But these computations make assumptions about tax incidence.

One approach: look at factor shares and wealth-income ratios and analyze how they respond to historical and international variations in tax structures.

Illustration with French national accounts:

Selected figures on factor shares and wealth-income ratios in France 1820-2008

Evolution of wealth-income ratios in rich countries 1870-2010

Methodological issues on the measurement of factor shares:

National income Y = Y_{c} + Y_{g }+ Y_{h} + Y_{se} (+ net foreign factor income)

= net income of corporate sector Y_{c} = Y_{Kc}+Y_{Lc} (= corporate profits + corporate wages)

+ net income of govt sector Y_{g} = Y_{Lg} (= govt sector wages) (=100% labor income)

+ net income of housing sector Y_{h }(=Y_{Kh} (=rental income) (=100% capital income)

+ net income of self-employment sector Y_{se} = Y_{Kse}+Y_{Lse} (=somewhat arbitrary)

[Course notes on the measurement of factor shares and wealth-income ratios]

What can conclude about tax incidence from the stability of factor shares & ratios? Not much: for a proper study of tax incidence, one needs micro data. But at least with macro data one can refute a number of naïve views. Here are the two standard (yet fragile) lessons that economists usually draw from stable factor shares and ratios:

(1) “Employer social contributions are paid by employers”: NO: the long-run & cross-country stability of factor shares suggests that social contributions and payroll taxes have been paid by labor; standard model

(theoretical model: Cobb-Douglas production function Y = F(K,L) = K^{α}L^{1-}^{α})

(elasticity of substitution K-L close to 1, labor demand elasticy close to 1 → price & volume effects exactly compensate → stable factor shares, regardless of supply elasticities)

(2) “Capital taxes are shifted to labor via lower capital accumulation”: NO: the long-run & cross-country stability of wealth-income ratios suggests that capital taxes have been paid by capital

(over 1970-2010 period, β=K/L rises, and α=rβ also tends to rise, i.e. average return r does not decline as much as the rise in β: this suggests long run elasticity of substitution σ>1)

(theoretical model: the long run elasticity of saving (capital supply) must be small; or at least no bigger than long run elasticity of labor supply (human capital))

(pb: many models, e.g. dynastic infinite-horizon model, routinely assume infinite elasticity of capital supply... with the obvious zero-capital-tax conclusion...)

(with infinite capital elasticity, long run net-of-tax rate of return must be equal to rate of time preference: (1-t)r=δ. I.e. β=α/r=(1-t)α/δ should fall proportionally as capital tax rates rise; this does not seem to be the case in the long run)

Microeconomic estimates of tax incidence allow for better identification:

- illustration with the incidence of housing benefits:

G. Fack "Are Housing Benefits An Effective Way To redistribute Income? Evidence From a Natural Experiment In France", *Labour Economics* 2006 [article in pdf format]

- illustration with the incidence of value added taxes (VAT):

C. Carbonnier, “Who Pays Sales Taxes ? Evidence from French VAT Reforms, 1987-1999”*,* Journal of Public Economics 2007 [article in pdf format]

**Lecture 3. Pigouvian corrective taxation: illustration with carbon taxes**

Basic theoretical model and optimal tax formulas with externalities: U(c,e,E)

Course notes on optimal corrective taxation of externalities

Putting numbers into the optimal tax formulas:

EU comparisons of energy & environmental taxes (Eurostat 2009)

Stern Report on the economic costs of global warming [Stern 2006 Report] and Quinet Report on the price of the carbon ton [Rapport Quinet 2008]

On time discounting: r* = δ + Γg

Stern 2008 (Chapter 2B): δ=0,1%, g=1,3% Γ=1, so r*=1,4%

Nordhaus: δ=0,1%, g=1,3% Γ=3, so r*=4,0%

See Nordhaus, "Critical Assumptions in the Stern Review on Climate Change", Science 2007; and JEL 2007 symposium

See also J. Sterner, "An Even Sterner Review: Introducing Relative Prices into the Discounting

Debate", JEP 2008

See also R. Guesnerie, "Calcul économique et développement durable", Revue économique 2004

O. Guéant, R. Guesnerie & J.M. Lasry, “Ecological intuition vs economic reason”, PSE Working Paper, 2009 [article in pdf format]

R. Guesnerie, "Pour une politique climatique globale", 2010

**Lecture 4. Income Taxes over Time and across Countries**

Current income tax schedules in France & the US: marginal tax rates t’(y) vs average tax rates t(y)/y [tax schedules in excel format]

Historical evolution of income tax in France & the US [Selected figures] [Other figures]

(figure 1: fraction of population subject to income tax) (figure 2: top marginal rate)

International perspectives:

A. Atkinson & T. Piketty, *Top incomes over the 20 ^{th} Century*, OUP 2007 & 2010

A. Atkinson, T. Piketty & E. Saez, “Top incomes in the long run of history”, forthcoming *Journal of Economic Literature* 2011 [article in pdf format]

On current evolutions in the developing world:

T. Piketty & N. Qian, « Income inequality and progressive income taxation in China and India: 1986-2015 », *AEJ* 2009 [article in pdf format]

On the political economy of fiscal development:

Besley-Persson, “On the Origins of State Capacity”,2009 [article in pdfformat]

(Kleven-Kreiner-Saez, “Why Can Modern Governments Tax so much?”, 2009, [article in pdf format])

On the impact of tax competition: see graphs on the evolution of personal and corporate tax rates in Europe

See Kopczuk 2012 on Polish flat tax

On the impact of personal income tax vs corporate tax vs wealth tax on overall tax progressivity:

T. Piketty et E. Saez, « How progressive is the U.S. federal tax system ? A historical and international perspective », *JEP*, 2006 [article in pdf format]

**Lecture 5. Optimal Redistributive Taxation of Labor Income**

Basic theoretical result: U-shaped pattern of marginal rates = relatively consistent with observed patterns, for reasons which seem relatively in line with those captured by the theory (except for the top Roosevelt-type tax rates)

Course notes on optimal redistributive taxation of labor income

Mirrlees, J., "An exploration in the theory of optimum income taxation", RES 1971

Diamond, P., “Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Rates”, AER 1998 [article in pdf format]

Saez, “Using Elasticities to Derive Optimal Income Tax Rates”, RES 2001 [article en format pdf]

Piketty-Saez, "Optimal Labor Income Taxation", 2012, forthcoming in Handbook of Public Economics, vol. 5

Observed pattern of marginal rates in France

Empirical estimates of labor supply elasticities:

E. Saez, J. Slemrod and S. Gierz, “The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review”, NBER 2009 [article en format pdf]

Roosevelt-type tax rates & recent surge in US top incomes

T. Piketty, E. Saez & S. Stantcheva, "Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities", WP 2012 (see also Slides)

**Lecture 6. Inheritance and Capital Taxes over Time and across Countries **

Eurostat 2010 : total tax burden EU27 = 39% of GDP, incl. 9% in capital taxes (US: 28%, incl. 8% in capital taxes)

Diversity of capital taxes: stock-based (one-off inheritance and transfer taxes, annual property or wealth taxes) or flow-based (corporate income taxes, taxes on capital income: rental income, interest, dividend, k gains etc.)

In principle, general equivalence result: if rate of return r=5%, equivalent to tax capital stock at 1% per year or to tax capital income flow at 20% per year. But in practice there are lots of differences: in particular r varies a lot across individuals and over assets.

Typically: inheritance taxes <1% GDP (say, 5%-10% of a 10% tax base)

+ annual wealth & property taxes 1%-2% GDP (say, 1% of a 100%-200% tax base)

+ corporate tax 2%-3% GDP (say, 20%-30% of a 10% tax base)

+ capital income tax 2%-3% GDP (say, 20%-30% of a 10% tax base)

Historical evolution of capital shares and wealth-income ratios

Current inheritance and wealth tax schedules in France & the US: marginal tax rates t’(w) vs average tax rates t(w)/w [tax schedules in excel format]

Estate or bequest taxes (the total wealth left by decedents) vs inheritance taxes (the wealth received by each successor)

(succession vs part successorale)

(US-UK vs France-Germany)

Historical evolution of top inheritance tax rates [Figures]

On the historical evolution of inheritance taxes:

K. Scheve & D. Stasavadge, “Democracy, War & Wealth – Evidence from Two Centuries of Inheritance Taxation”, 2011 [article in pdf format]

On the recent evolution of the French wealth tax (ISF) :

Zucman, G., “Les hauts patrimoines fuient-ils l’ISF? Une estimation sur la période 1995-2006 », PSE Master Thesis, 2008 [article in pdf format]

**Lecture 7. Optimal Taxation of Inheritance & Capital **

Basic theoretical result = zero optimal capital tax rate = mechanical implication of Atkinson-Stiglitz no-differential-commodity-tax result to intertemporal consumption (=relies on several assumptions: 100% lifecycle wealth (zero inheritance) & perfect capital markets; or infinite horizon & perfect capital markets)

Course notes on optimal redistributive taxation of capital and capital income

Pb = formulas get very complicated in more realistic settings (i.e. finite horizon models with inheritance, and/or models with imperfect capital markets) = an area where much progress is needed

Some (limited) progress:

T. Piketty & E. Saez, "A Theory of Optimal Capital Taxation", WP 2012 (see also Slides)

On the difficulties of taxing capital with international capital mobility, tax competition and the residence principle of taxation:

K. Clausing, "In Search of Corporate Tax Incidence", WP 2011 Tax Law Review 2012

N. Johanssen and G. Zucman,, "The End of Bank Secrecy? An Evaluation of the G20 Tax Haven Crackdown", WP 2012

G. Zucman, “The missing wealth of nations”, WP 2012