CONTENTS
L1: TAX INCIDENCE ............................................................................................................................................................. 5
L1.1 Partial Equilibrium (“P-E”) Tax Incidence ........................................................................................................... 5
L1.1.1 Standard P-E Tax Incidence Theory ............................................................................................................ 5
L1.4.2 Standard Incidence Results and Efficiency Loss of Taxation ...................................................................... 6
L1.1.2 Empirical Applications of P-E Incidence Theory ......................................................................................... 7
L1.2 P-E Incidence Extensions: Salience / Information.............................................................................................. 7
L1.3 P-E Incidence Extensions: Imperfect Competition ............................................................................................. 8
L1.4 P-E Incidence Extensions: Evasion and Enforcement......................................................................................... 8
L1.5 General Equilibrium (“G-E”) Tax Incidence ........................................................................................................ 8
L2: INCOME AND WEALTH INEQUALITY ...........................................................................................................................10
L2.1 National Income ...............................................................................................................................................10
L2.1.1 National Income: Definitions and Objectives ..........................................................................................10
L2.1.2 The Link Between Income and Wealth ....................................................................................................10
L2.1.3 Functional vs Personal Income Distribution ............................................................................................10
L2.2 The Declining Labour Income Share ................................................................................................................11
L2.2.1 Trends in Factor Shares ............................................................................................................................11
L2.2.2 Theories of Factor Shares ........................................................................................................................11
L2.2.3 Summary of Factor Shares .......................................................................................................................12
L2.3 Labour Income Inequality ................................................................................................................................12
L2.3.1 Income Inequality: Basic Orders of Magnitude and Trends.....................................................................12
L2.3.2 The Race Between Education and Technology ........................................................................................12
L2.4 Wealth Inequality .............................................................................................................................................13
L2.4.1 Estimating Wealth Inequality ...................................................................................................................13
L2.4.2 Facts about Wealth Inequality: Great Reversal........................................................................................13
L2.4.3 Models of the Wealth Distribution ..........................................................................................................13
L3: TAXES, TRANSFERS, AND LABOUR SUPPLY .................................................................................................................15
L3.1 Tax and Labour Supply Theory .........................................................................................................................15
L3.1.1 Why Care About Labour Supply Responses? ...........................................................................................15
L3.1.2 Dimensions of Labour Supply Response ..................................................................................................15
L3.1.3 Standard Static Labour Supply Model......................................................................................................15
L3.1.4 Labour Supply Elasticities.........................................................................................................................16
L3.1.5 Convexity Assumption..............................................................................................................................16
L3.2 Estimating Labour Supply ................................................................................................................................18
L3.2.1 Basic Regression Analysis .........................................................................................................................18
L3.2.1 Recent Empirical Work on Labour Supply ................................................................................................18
L3.2.2 In-Work Benefit Programmes ..................................................................................................................18
L4: POVERTY ALLEVIATION ...............................................................................................................................................20
L4.1 Inequality vs Poverty ........................................................................................................................................20
, L4.2 Types of Transfer Programmes.........................................................................................................................20
L4.2.1 Types of Programmes: Eligibility ..............................................................................................................20
L4.2.2 Types of Programmes: Benefit Type ........................................................................................................20
L4.2.3 A Means-Tested Programme ....................................................................................................................20
L4.3 Okun’s Leaky Bucket and Moral Hazard ...........................................................................................................21
L4.3.1 The Information Constraint ......................................................................................................................21
L4.4 Increasing Targeting Efficiency .........................................................................................................................21
L4.4.1 Tagging .....................................................................................................................................................21
L4.4.2 In-Kind Benefits (Goods Subsidies) ..........................................................................................................22
L4.4.3 Ordeals .....................................................................................................................................................22
L4.4.3 Ordeals: Potential Costs / Incomplete Take Up........................................................................................22
L5: MIGRATION AND THE TAX AND TRANSFER SYSTEM ..................................................................................................24
L5.1 Migration Theory: Taxes, Transfers, and Incentives to Migrate .......................................................................24
L5.1.1 Why Focus on Taxation and Migration? ...................................................................................................24
L5.1.2 Individual’s Location Choice .....................................................................................................................24
L5.2.3 Government’s Role...................................................................................................................................24
L5.2 Empirical Evidence: Effect of Taxes on Migration of High-Skill Labour ............................................................24
L5.2.1 Identification Difficulty.............................................................................................................................24
L5.2.2 Evidence: Effect of Taxes on Migration of High-Skill Labour ....................................................................24
L5.3 Empirical Evidence: Effect of Transfers on Migration of Low-Skill Labour .......................................................26
L5.3.1 Welfare Magnet Hypothesis ....................................................................................................................26
L5.2.2 Evidence: Effect of Transfers on Migration of Low-Skill Labour ...............................................................26
L6: INCOME AND BEHAVIOURAL RESPONSES AT THE TOP OF THE DISTRIBUTION .........................................................27
L6.1 Elasticity of Taxable Income (“ETI”) .................................................................................................................27
L6.1.1 Note on Taxable Income Response ..........................................................................................................27
L6.1.2 Channels of Taxable Income Response ....................................................................................................27
L6.1.3 Why Focus on the ETI? .............................................................................................................................27
L6.1.4 The ETI Literature .....................................................................................................................................27
L6.2 Long-Run Evolution of Top Marginal Tax Rates and Top Income Shares .........................................................28
L6.3 Top Income Share Analysis: U.S. Data ..............................................................................................................28
L6.3.1 Top Income Share Analysis: Controlling for Trending Inequality .............................................................29
L6.4 Top Income Share Analysis: U.K. Data 1962–2003 (Brewer, Saez, and Shepard, 2010) ..................................29
L6.4.2 Top Income Share Analysis: Controlling for Trending Inequality .............................................................29
L6.5 An Application of the ETI: The Laffer Curve .....................................................................................................30
L6.5.1 The High-Income Laffer Rate ...................................................................................................................30
L6.5.2 The ETI as a Policy Instrument .................................................................................................................31
L6.6 Anatomy of Behavioural Response ..................................................................................................................31
L6.7 ETI and Bunching at Tax Kinks ..........................................................................................................................31
L7: OPTIMAL INCOME TAXATION .....................................................................................................................................33
, L7.1 Fundamental Theorems of Welfare Economics ...............................................................................................33
L7.1.1 First and Second Fundamental Theorems of Welfare Economics ...........................................................33
L7.1.2 Efficiency vs Equality ................................................................................................................................33
L7.1.3 Information Constraint: First-Best vs Second-Best ..................................................................................33
L7.2 Labour Income Taxation Deadweight Loss.......................................................................................................34
L7.2.1 Marginal Deadweight Loss of Income Taxation .......................................................................................34
L7.3 Optimal Income Tax Problem ...........................................................................................................................35
L7.3.1 Simplified Optimal Income Tax Problem ..................................................................................................35
L7.3.2 The Linear Income Tax Model ..................................................................................................................35
L7.3.2 Social Welfare Functions ..........................................................................................................................36
L7.4 The Laffer Curve and Its Relation to Optimal Income Taxation: Linear and Piecewise Linear .........................36
L7.5 Income vs Consumption Taxes .........................................................................................................................37
L7.6 What Do People’s Social Preferences Look Like? .............................................................................................37
L8: TAX INEFFICIENCIES AND OPTIMAL COMMODITY TAXATION ....................................................................................39
L8.1 Reasons for Imposing Commodity Taxes .........................................................................................................39
L8.2 The Deadweight Loss from Commodity Taxation ............................................................................................39
L8.3 Ramsey Optimal Tax Model and Inverse Elasticity Rule ..................................................................................40
L8.3.1 A Simplified Ramsey Model .....................................................................................................................40
L8.3.2 The Ramsey Problem ...............................................................................................................................40
L8.3.3 The Inverse Elasticity Rule........................................................................................................................41
L8.4 The Debate Over Uniformity Versus Differentiation ........................................................................................41
L8.5 Extending the analysis: Equity Concerns, Externalities, and Internalities .......................................................42
L8.5.1 Equity Concerns: Ramsey Model .............................................................................................................42
L8.5.2 Externalities .............................................................................................................................................42
L8.5.3 Internalities ..............................................................................................................................................42
L8.6 Case Studies .....................................................................................................................................................43
L8.6.1 Case Study #1: Putting It All Together - Cigarette Taxes...........................................................................43
L8.6.2 Case Study #2: Heterogenous Externalities: Alcohol Taxes .....................................................................43
L9: TAXATION AND CAPITAL INCOME ...............................................................................................................................44
L9.1 Motivation and Descriptive Facts on Wealth and Capital Income ...................................................................44
L9.2 Savings vs Inheritance ......................................................................................................................................44
L9.3 A Simple 2-Period Model .................................................................................................................................46
L9.3.1 2-Period Model: No Tax ...........................................................................................................................46
L9.3.1 2-Period Model: Consumption and Labour Income Tax ..........................................................................46
L9.3.2 2-Period Model: Income Tax ....................................................................................................................46
L9.4 Atkinson and Stiglitz (1976): Lifecycle Model for Optimal Capital Income Taxation .......................................48
L9.4.1 Atkinson and Stiglitz’s Lifecycle Model (1976) .........................................................................................48
L9.4.2 Limits of the Lifecycle Model for Optimal Capital Income Taxation ........................................................48
L9.5 Taxation of Inheritances ...................................................................................................................................48
, L9.5.1 Taxing Inheritance: Welfare Effects..........................................................................................................48
L9.5.2 Taxing Inheritance: Behavioural Responses .............................................................................................49
L10: TAXATION AND ECONOMIC DEVELOPMENT ............................................................................................................50
L10.1 Lessons from Optimal Tax Theory ................................................................................................................50
L10.2 Actual Tax Systems Across Countries and Over Time ..................................................................................50
L10.2.1 Tax Systems Across Countries ..................................................................................................................50
L10.2.1 Tax Systems Over Time.............................................................................................................................51
L10.2.3 Theories Explaining Stylised Facts ...........................................................................................................52
L10.3 Tax Enforcement and Tax Evasion ................................................................................................................52
L10.3.1 Theory: Allingham and Sandmo Model (1972) ........................................................................................52
L10.3.2 Empirical Evidence ...................................................................................................................................52
L1: TAX INCIDENCE ............................................................................................................................................................. 5
L1.1 Partial Equilibrium (“P-E”) Tax Incidence ........................................................................................................... 5
L1.1.1 Standard P-E Tax Incidence Theory ............................................................................................................ 5
L1.4.2 Standard Incidence Results and Efficiency Loss of Taxation ...................................................................... 6
L1.1.2 Empirical Applications of P-E Incidence Theory ......................................................................................... 7
L1.2 P-E Incidence Extensions: Salience / Information.............................................................................................. 7
L1.3 P-E Incidence Extensions: Imperfect Competition ............................................................................................. 8
L1.4 P-E Incidence Extensions: Evasion and Enforcement......................................................................................... 8
L1.5 General Equilibrium (“G-E”) Tax Incidence ........................................................................................................ 8
L2: INCOME AND WEALTH INEQUALITY ...........................................................................................................................10
L2.1 National Income ...............................................................................................................................................10
L2.1.1 National Income: Definitions and Objectives ..........................................................................................10
L2.1.2 The Link Between Income and Wealth ....................................................................................................10
L2.1.3 Functional vs Personal Income Distribution ............................................................................................10
L2.2 The Declining Labour Income Share ................................................................................................................11
L2.2.1 Trends in Factor Shares ............................................................................................................................11
L2.2.2 Theories of Factor Shares ........................................................................................................................11
L2.2.3 Summary of Factor Shares .......................................................................................................................12
L2.3 Labour Income Inequality ................................................................................................................................12
L2.3.1 Income Inequality: Basic Orders of Magnitude and Trends.....................................................................12
L2.3.2 The Race Between Education and Technology ........................................................................................12
L2.4 Wealth Inequality .............................................................................................................................................13
L2.4.1 Estimating Wealth Inequality ...................................................................................................................13
L2.4.2 Facts about Wealth Inequality: Great Reversal........................................................................................13
L2.4.3 Models of the Wealth Distribution ..........................................................................................................13
L3: TAXES, TRANSFERS, AND LABOUR SUPPLY .................................................................................................................15
L3.1 Tax and Labour Supply Theory .........................................................................................................................15
L3.1.1 Why Care About Labour Supply Responses? ...........................................................................................15
L3.1.2 Dimensions of Labour Supply Response ..................................................................................................15
L3.1.3 Standard Static Labour Supply Model......................................................................................................15
L3.1.4 Labour Supply Elasticities.........................................................................................................................16
L3.1.5 Convexity Assumption..............................................................................................................................16
L3.2 Estimating Labour Supply ................................................................................................................................18
L3.2.1 Basic Regression Analysis .........................................................................................................................18
L3.2.1 Recent Empirical Work on Labour Supply ................................................................................................18
L3.2.2 In-Work Benefit Programmes ..................................................................................................................18
L4: POVERTY ALLEVIATION ...............................................................................................................................................20
L4.1 Inequality vs Poverty ........................................................................................................................................20
, L4.2 Types of Transfer Programmes.........................................................................................................................20
L4.2.1 Types of Programmes: Eligibility ..............................................................................................................20
L4.2.2 Types of Programmes: Benefit Type ........................................................................................................20
L4.2.3 A Means-Tested Programme ....................................................................................................................20
L4.3 Okun’s Leaky Bucket and Moral Hazard ...........................................................................................................21
L4.3.1 The Information Constraint ......................................................................................................................21
L4.4 Increasing Targeting Efficiency .........................................................................................................................21
L4.4.1 Tagging .....................................................................................................................................................21
L4.4.2 In-Kind Benefits (Goods Subsidies) ..........................................................................................................22
L4.4.3 Ordeals .....................................................................................................................................................22
L4.4.3 Ordeals: Potential Costs / Incomplete Take Up........................................................................................22
L5: MIGRATION AND THE TAX AND TRANSFER SYSTEM ..................................................................................................24
L5.1 Migration Theory: Taxes, Transfers, and Incentives to Migrate .......................................................................24
L5.1.1 Why Focus on Taxation and Migration? ...................................................................................................24
L5.1.2 Individual’s Location Choice .....................................................................................................................24
L5.2.3 Government’s Role...................................................................................................................................24
L5.2 Empirical Evidence: Effect of Taxes on Migration of High-Skill Labour ............................................................24
L5.2.1 Identification Difficulty.............................................................................................................................24
L5.2.2 Evidence: Effect of Taxes on Migration of High-Skill Labour ....................................................................24
L5.3 Empirical Evidence: Effect of Transfers on Migration of Low-Skill Labour .......................................................26
L5.3.1 Welfare Magnet Hypothesis ....................................................................................................................26
L5.2.2 Evidence: Effect of Transfers on Migration of Low-Skill Labour ...............................................................26
L6: INCOME AND BEHAVIOURAL RESPONSES AT THE TOP OF THE DISTRIBUTION .........................................................27
L6.1 Elasticity of Taxable Income (“ETI”) .................................................................................................................27
L6.1.1 Note on Taxable Income Response ..........................................................................................................27
L6.1.2 Channels of Taxable Income Response ....................................................................................................27
L6.1.3 Why Focus on the ETI? .............................................................................................................................27
L6.1.4 The ETI Literature .....................................................................................................................................27
L6.2 Long-Run Evolution of Top Marginal Tax Rates and Top Income Shares .........................................................28
L6.3 Top Income Share Analysis: U.S. Data ..............................................................................................................28
L6.3.1 Top Income Share Analysis: Controlling for Trending Inequality .............................................................29
L6.4 Top Income Share Analysis: U.K. Data 1962–2003 (Brewer, Saez, and Shepard, 2010) ..................................29
L6.4.2 Top Income Share Analysis: Controlling for Trending Inequality .............................................................29
L6.5 An Application of the ETI: The Laffer Curve .....................................................................................................30
L6.5.1 The High-Income Laffer Rate ...................................................................................................................30
L6.5.2 The ETI as a Policy Instrument .................................................................................................................31
L6.6 Anatomy of Behavioural Response ..................................................................................................................31
L6.7 ETI and Bunching at Tax Kinks ..........................................................................................................................31
L7: OPTIMAL INCOME TAXATION .....................................................................................................................................33
, L7.1 Fundamental Theorems of Welfare Economics ...............................................................................................33
L7.1.1 First and Second Fundamental Theorems of Welfare Economics ...........................................................33
L7.1.2 Efficiency vs Equality ................................................................................................................................33
L7.1.3 Information Constraint: First-Best vs Second-Best ..................................................................................33
L7.2 Labour Income Taxation Deadweight Loss.......................................................................................................34
L7.2.1 Marginal Deadweight Loss of Income Taxation .......................................................................................34
L7.3 Optimal Income Tax Problem ...........................................................................................................................35
L7.3.1 Simplified Optimal Income Tax Problem ..................................................................................................35
L7.3.2 The Linear Income Tax Model ..................................................................................................................35
L7.3.2 Social Welfare Functions ..........................................................................................................................36
L7.4 The Laffer Curve and Its Relation to Optimal Income Taxation: Linear and Piecewise Linear .........................36
L7.5 Income vs Consumption Taxes .........................................................................................................................37
L7.6 What Do People’s Social Preferences Look Like? .............................................................................................37
L8: TAX INEFFICIENCIES AND OPTIMAL COMMODITY TAXATION ....................................................................................39
L8.1 Reasons for Imposing Commodity Taxes .........................................................................................................39
L8.2 The Deadweight Loss from Commodity Taxation ............................................................................................39
L8.3 Ramsey Optimal Tax Model and Inverse Elasticity Rule ..................................................................................40
L8.3.1 A Simplified Ramsey Model .....................................................................................................................40
L8.3.2 The Ramsey Problem ...............................................................................................................................40
L8.3.3 The Inverse Elasticity Rule........................................................................................................................41
L8.4 The Debate Over Uniformity Versus Differentiation ........................................................................................41
L8.5 Extending the analysis: Equity Concerns, Externalities, and Internalities .......................................................42
L8.5.1 Equity Concerns: Ramsey Model .............................................................................................................42
L8.5.2 Externalities .............................................................................................................................................42
L8.5.3 Internalities ..............................................................................................................................................42
L8.6 Case Studies .....................................................................................................................................................43
L8.6.1 Case Study #1: Putting It All Together - Cigarette Taxes...........................................................................43
L8.6.2 Case Study #2: Heterogenous Externalities: Alcohol Taxes .....................................................................43
L9: TAXATION AND CAPITAL INCOME ...............................................................................................................................44
L9.1 Motivation and Descriptive Facts on Wealth and Capital Income ...................................................................44
L9.2 Savings vs Inheritance ......................................................................................................................................44
L9.3 A Simple 2-Period Model .................................................................................................................................46
L9.3.1 2-Period Model: No Tax ...........................................................................................................................46
L9.3.1 2-Period Model: Consumption and Labour Income Tax ..........................................................................46
L9.3.2 2-Period Model: Income Tax ....................................................................................................................46
L9.4 Atkinson and Stiglitz (1976): Lifecycle Model for Optimal Capital Income Taxation .......................................48
L9.4.1 Atkinson and Stiglitz’s Lifecycle Model (1976) .........................................................................................48
L9.4.2 Limits of the Lifecycle Model for Optimal Capital Income Taxation ........................................................48
L9.5 Taxation of Inheritances ...................................................................................................................................48
, L9.5.1 Taxing Inheritance: Welfare Effects..........................................................................................................48
L9.5.2 Taxing Inheritance: Behavioural Responses .............................................................................................49
L10: TAXATION AND ECONOMIC DEVELOPMENT ............................................................................................................50
L10.1 Lessons from Optimal Tax Theory ................................................................................................................50
L10.2 Actual Tax Systems Across Countries and Over Time ..................................................................................50
L10.2.1 Tax Systems Across Countries ..................................................................................................................50
L10.2.1 Tax Systems Over Time.............................................................................................................................51
L10.2.3 Theories Explaining Stylised Facts ...........................................................................................................52
L10.3 Tax Enforcement and Tax Evasion ................................................................................................................52
L10.3.1 Theory: Allingham and Sandmo Model (1972) ........................................................................................52
L10.3.2 Empirical Evidence ...................................................................................................................................52
