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The efficiency and welfare effects of tax reform: are fewer tax brackets better than more?
Abstract
A comparison of a simple two-bracket income tax code with an approximation to traditional structures that entail steeply rising marginal tax rates, showing that the simpler rate structures are not necessarily more efficient than alternatives with many, highly progressive brackets.
... However, with these changes came the reduction in a number of tax brackets which entailed having broad bands of income over which marginal tax rates are constant in conjunction with discontinuous jumps in marginal tax rates -"kinks" (Altig and Carlstrom, 1994). These changes to the tax codes have the potential to induce tax avoidance incentives which could erode the expected benefits of tax policies. ...
... Even though the reforms were aimed at making the tax systems more efficient, there is limited empirical evidence to support such claims (Altig and Carlstrom, 1994). ...
... First, I focus on firms' strategic responses to taxation, which has not received much attention in public finance. Most empirical literature has focused on strategic responses of households to changes in tax rate structure (Feldstein, 1995;Saez, 2010;Altig and Carlstrom, 1994;Chetty et al., 2011). Additionally, the longer study period enables me to examine and compare the strategic responses across different tax schedules. ...
This dissertation focuses on firms’ strategic responses to taxation and the welfare implications of changes in tax structure. The dissertation is comprised of three essays. In the first essay, I use the Tax Reform Act of 1986 to investigate how firms adjust their tax strategies in response to the tax incentives induced by the reform. The results in essay one suggest that the 1986 reform created incentives for firms following a sustainable tax strategy to engage in more tax avoidance behavior. In essay two, I test for the presence of strategic cost shifting behavior by examining the distribution of taxable income around kinks in the corporate tax code. Specifically, the McCrary’s (2008) density test, which was developed as a validity test in regression discontinuity design (RDD) is applied to a data set of US firms for the period 1988-2010. The results show that reported taxable income has a tendency to bunch at levels just under upward kinks in the marginal tax rate. Conversely, taxable income tends to exhibit gaps in the region below a downward kink in marginal tax rates. Both findings suggest that firms manipulate taxable income in response to kinks in the corporate tax code. In essay three, I provide an explicit model that illustrates the incentives for strategic cost shifting behavior when the tax code exhibits kinks. In the presence of upward kinks in marginal tax rates, profit maximizing firms will choose a path for investment that makes pre-profits bunch just below the kink point. I then use the model to quantify the welfare cost of kinks in the marginal tax rates. Additionally, I find that replacing a kinked tax code with one in which marginal tax rates rise smoothly retains the progressivity inherent in the current tax code while largely avoiding the welfare costs associated with large jumps in marginal tax rates. Adviser: Matthew J. Cushing
This paper proposes a method for evaluating the impact of tax structure changes on tax revenue. The technique consists of decomposing the gap between actual revenue and potential revenue into components attributable to changes in (i) the tax rate structure (ii) deductions and (iii) tax evasion. Our results indicate that, for the Indian reform episode we examine, there were initial gains which could not be sustained over time. The magnitude of the gains from the reform were limited and failed to significantly curtail losses from tax evasion. Copyright Kluwer Academic Publishers 2000
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