Magyar Nemzeti Bank June 2012

1. Assessing changes of the tax-transfer
system: A new general equilibrium
microsimulation approach
Péter Benczúr Gábor Kátay Áron Kiss
Magyar Nemzeti Bank
June 2012
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MAGYAR NEMZETI BANK
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2. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Public finance: the impact of taxation
• What and why should we know about behavioural responses to
taxation?
effectiveness and efficiency of government interventions
• What can we do if we know them?
Can use them in micro-based predictions for tax and welfare
reforms
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3. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Taxation
• Standard approach: need to generate some revenue
Collect taxes on various economic transactions like sales,
corporate and personal income
Ideal setup: ”lump sum taxation” - regardless of individual
choice
Reality: taxes influence prices, thus choices - a source of
potential inefficiency
How to minimize the efficiency loss?
• Variant 2: want to redistribute income
Again a loss due to distorted individual choices
Need to tradeoff efficiency vs equity
• The sensitivity of individual behavior to taxes is always a key
ingredient of the evaluation
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4. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Elasticities and efficiency losses
price price
demand demand
p1consumer
p1consumer
tax
tax
supply supply
p0 = p1producer p0 = p1producer
q1 q0 quantity q1 q0 quantity
Lost consumer surplus
- Revenue gain
= Welfare loss
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5. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Public finance at a central bank?
• Fiscal policy becoming (even more) important
Budget consolidation needs will put pressure on minimizing the
GDP loss
A strong impact on economic performance, both at a business
cycle (”gap”) and growth (”trend”) frequency
”DG Research will have to expand its research capabilities in
the areas of [...] fiscal policy issues in the European Union.”
(from the External Review)
• Hungary in particular:
Very low participation rates (around 62%)
We identified this as the most important bottleneck to real
convergence
Recent and future fiscal reforms are centered around labour
market activity
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6. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Tax, transfer and labour supply
• Adjustment at the intensive and the extensive margin
• Marginal Tax Rate (MTR):
tax rate on the last unit of income
it should discourage work activity (”substitution” effect)
• Average Tax Rate (ATR):
total taxes per total income
it may encourage activity (”income” effect)
it also influences the overall payoff from taking up a job
(”participation tax rate”)
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7. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Impact of a tax change - figures
c c
Ui c=wl+T Ui
c=wl+T
Ui ' Ui'
c=w'l+T c=w'l+T
T T
l he hf he' l he hf
(a) Intensive margin (b) Extensive margin
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8. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Transfers
• Show both aspects:
Marginal:
◃ Means tested benefits with gradual phase-out
◃ Every extra euro earned as wage reduces transfers by 20% is
equivalent to a 20% extra MTR
Participation tax rate:
◃ The total amount of lost transfers decrease the payoff from work
◃ The relevant concept is the change in disposable income due to
getting a job
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9. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Impact of transfers - figure
c
Ui
c=wl+(T-ΔT)
T
T-ΔT
l l*
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10. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Labour supply at the intensive margin
• Hours worked:
Very little behavioral response for primary workers
Slightly bigger effect on how much secondary earners work
• Total taxable income:
Quite substantial elasticities in many countries (around 0.4),
higher for high earners
Hungary: Bakos et al (2008) and Kiss-Mosberger (2011)...
... small elasticity for the whole population (0.065)
... much higher for top 20% earners: 0.35, or for the top 5%: 0.2
... income effect is also important for the top earners:−0.27
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11. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Labour supply at the extensive margin
• Hardly comparable results across studies and countries
special subgroups (mostly secondary earners, married
women...)
the way after-tax wages are controlled for varies across studies
mostly reduced form, program evaluation methodology
• Taxes and transfers rarely taken simultaneously into account
lost transfers are the main parts of the budget constraint of
many important subgroups: low-skilled, elders, maternity leave
• Benczúr-Kátay-Kiss-Rácz (2012): such groups are highly
responsive to tax and transfer changes; prime age (25-54)
higher educated individuals are unresponsive at the extensive
margin
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12. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Labour supply at the extensive margin (cont’d)
working-age population prime-age (25-54)
dy/dx std. err. dy/dx std. err.
full sample net wage 0.341 0.036 0.095 0.012
transfer -0.157 0.016 -0.056 0.007
elementary school or less net wage 0.399 0.088 0.333 0.040
transfer -0.171 0.038 -0.202 0.024
secondary education net wage 0.263 0.029 0.095 0.011
transfer -0.134 0.015 -0.058 0.006
tertiary education net wage 0.115 0.013 0.037 0.003
transfer -0.053 0.006 -0.021 0.002
elder (>=50) net wage 0.402 0.051
transfer -0.128 0.016
women at child-bearing age (25-49) net wage 0.178 0.020
transfer -0.111 0.012
prime-age, single men net wage 0.062 0.009
transfer -0.035 0.005
prime-age, single women net wage 0.121 0.017
transfer -0.072 0.010
prime-age, married men net wage 0.031 0.004
transfer -0.018 0.002
prime-age, married women net wage 0.240 0.024
transfer -0.147 0.015
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13. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Our approach
• Assessing the impact of tax and transfer reforms:
Static effects (impact on incomes and the income
distribution…)
Labour supply effects (not short run “consumption effect”!)
Long-run(!) general equilibrium effects (GDP, capital stock,
employment…)
Fiscal effects in the short-run and the long-run
• With a microsimulation model
...that takes into account the labour supply decision
...both at the extensive and the intensive margin
...embedded into a small neoclassical macro model
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14. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Advantages of our approach
• Relative to macro models:
Household heterogeneity taken into account
Nonlinearity of the income tax (even of a “flat tax”)
Heterogeneous sensitivity to taxation
• Relative to pure microsimulation models:
Behavioural response incorporated
General equilibrium also taken into account
• Relative to dynamic microsimulation models
Most models have either GE feed backs or behavioural
responses
Early behavioural models modelled only the intensive margin
Many models use calibrated elasticities
Information often flows only in only one direction
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15. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Overview of the model - extensive margin
• Calculate pre- and post-reform net wages
Observed wage for the employed
Predicted wage for the unemployed
• Calculate pre- and post-reform hypothetical transfers
• Assess the pre- and post-reform probability of activity
(P (ai = 1))
• The change in the weighted sum of individual probabilities
∑
( i si P (ai = 1)) gives the aggregate labour supply shock at the
extensive margin (employment)
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16. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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The model - intensive margin
• Calculate pre- and post-reform (1 − MTR) and (1 − ATR)
• Pre-reform “work intensity” is normalized to 1, post-reform
value (hi ) is given by the labour supply equation at the
intensive margin
• We take into account individuals’ productivity (ωi )
• We iterate until convergence
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17. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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The macro model
• The “effective” aggregate labour supply shock (extensive +
∑ ∑
intensive) is: si P (ait = 1) ωi hi − si P (ait−1 = 1) ωi
• This will feed into a small neoclassical macromodel:
marginal revenue = marginal cost
capital supply is (almost) perfectly elastic (small open
economy)
gross wages adjust perfectly in the long-run
steady-state to steady state
static fiscal effects also reflect steady-state values
• Short-run dynamics behind the model after tax cut:
1. gross wages decrease, thus, return on capital exceeds the
required rate of return
2. demand for capital and labour adjust
3. factor prices slowly return to their original levels
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18. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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What reforms are we looking at?
• Three versions of a personal income tax cut (0.8% of GDP)
Across the board rate cut
“Flat tax” with a zero bracket
“Flat tax” with a wage tax credit
• Three tax reorganizations (reshuffling 0.8% of GDP)
Increasing the corporate tax rate, decreasing the PIT
Increasing the effective retirement age, PIT cut
Increasing the effective retirement age, corporate tax cut
• Tax and transfer reforms 2008-10 and 2010-12
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19. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Hypothetical PIT scenarios
Across-the-board 2 tax rates (0% + 29.5%) 1 tax rate (23%) + tax credit
static dynamic static dynamic static dynamic
Effective labour 0.9% 1.7% 3.2%
Employment 0.7% 0.0% 0.3%
Capital stock 0.8% 1.3% 2.6%
GDP 0.9% 1.5% 2.9%
Average gross wage -0.1% -0.1% -0.3%
Disposable income 2.9% 3.4% 4.5%
Personal income tax -235 -214 -240 -197 -246 176
Employee contributions 0 14 0 23 0 45
Employer contributions 0 24 0 44 0 91
VAT 43 51 44 60 45 79
Capital taxes 0 6 0 10 0 19
Local business tax 0 4 0 7 0 14
Transfers 0 9 0 1 0 -3
Change of budget balance -192 -107 -197 -52 -201 69
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20. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Hypothetical tax & transfer scenarios
capital tax increase restricted early restricted early
+ labour tax cut retirement + labour tax retirement + capital
cut tax cut
static dynamic static dynamic static dynamic
Effective labour 2.7% 4.8% 2.3%
Employment -0.2% 2.1% 2.3%
Capital stock -4.9% 3.9% 8.8%
GDP 0.0% 4.5% 4.6%
Average gross wage -3.3% -0.4% 2.9%
Disposable income 2.2% 3.2% 0.9%
Personal income tax -246 -268 249 -151 -12 135
Employee contributions 0 -11 1 71 1 84
Employer contributions 0 -22 0 132 0 156
VAT 45 38 3 56 -40 15
Capital taxes 234 216 0 29 -234 -188
Local business tax 0 0 0 21 0 21
Transfers 0 -10 229 228 231 239
Change of budget balance 33 -56 -16 385 -54 463
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21. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Actual measures 2008-2010 and 2010-2012
• Both periods:
Increase in (employee-side) contributions
Increase in VAT (20 to 25 to 27%)
Measures to postpone retirement
• 2008-2010:
PIT cut for middle-income individuals
Cut in employer-side contributions
• 2010-2012:
PIT cut for high-income individuals
PIT increase for low income earners, cut for families w.
children
Corporate tax cut
Extraordinary “crisis” taxes on banks, telecom, retail
Cut in unemployment benefits (12 months to 3 months)
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22. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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2008-10 and 2010-12
2008-2010, 2008-2010, 2010-2012, 2010-2012,
without with without with
pension pension pension pension
measure measure measure measure
static dynamic static dynamic static dynamic static dynamic
Effective labour 1.6% 3.6% 3.4% 5.2%
Employment 2.3% 4.7% 0.6% 2.3%
Capital stock 1.2% 3.0% 5.9% 7.3%
GDP 1.4% 3.4% 4.3% 5.9%
Average gross wage 4.1% 4.0% 1.1% 0.9%
Disposable income 5.6% 4.4% 2.4% 1.1%
Personal income tax -333 -217 -337 -185 -322 -241 -321 -215
Employee contributions 3 89 4 126 136 214 137 244
Employer contributions -560 -418 -560 -368 0 116 0 154
VAT 179 247 129 227 177 242 125 213
Capital taxes 0 8 0 22 -103 -68 -103 -58
Local business tax -24 -18 -24 -9 0 19 0 26
Transfers 4 22 264 285 63 66 311 315
Change of budget balance -732 -287 -525 98 -48 348 149 680
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23. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Hypothetical risk premium scenarios
0 pp 0.25pp 0.5 pp 1 pp “crisis taxes”; no
r.p. shock
Effective labour 3.4% 3.1% 2.8% 2.1% 2.9%
Employment 0.6% 0.2% -0.1% -0.7% 0.0%
Capital stock 5.9% 1.0% -3.7% -13.0% -1.9%
GDP 4.3% 2.4% -0.5% -3.2% 1.2%
Average gross wage 1.1% -0.9% -2.8% -6.5% -2.1%
Disposable income 2.4% 0.8% -0.8% -3.8% -0.1%
Personal income tax -241 -280 -319 -393 -303
Employee contributions 214 173 134 57 149
Employer contributions 116 53 -8 -126 16
VAT 242 208 174 109 187
Taxes on capital -68 -92 -115 -161 138
Local business tax 19 10 2 -14 5
Transfers 66 62 60 55 61
Total 348 135 -71 -474 253
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24. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Effect on the income distribution
• Substantial redistribution (static effect)
Tax changes favored the high-income (mostly: above an annual
income of 4M Ft)
The elimination of wage tax credit and changes in transfers
hurt low-income households
• Income inequality measures (the Gini coefficient, p90/p10
etc. ratios):
Move from a low level similar to Denmark and Austria to a
medium level similar to Germany (EU average)
This is the dynamic effect
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25. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Distributional impacts
2008 2010 2012
without with without with
pension pension pension pension
measure measure measure measure
GINI 25.7 26.8 26.7 29.8 29.9
P90/P10 2.97 3.21 3.19 3.51 3.53
P90/P50 1.73 1.82 1.80 1.95 1.95
P50/P10 1.72 1.77 1.77 1.78 1.81
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26. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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GINI index
40
35
30
25
20
Belgium
Slovenia
Denmark
Cyprus
Italy
Portugal
Finland
Netherlands
Greece
Lithuania
Latvia
Malta
Sweden
Hungary
Ireland
Spain
Poland
Czech Republic
Austria
Luxembourg
France
Germany
Estonia
United Kingdom
Bulgaria
Slovakia
Hungary (hypo)
Romania
EU-27
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27. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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General conclusions
1. Our behavioural GE microsimulation model is able to assess
effects of various tax and transfer changes.
The dynamic effects are long-run, supply-driven
Important to take taxes and transfers simultaneously into
account
2. Tax cuts for high-income individuals may boost reported
income and thus GDP but they do relatively little for
employment
3. Low average taxes at low incomes increase employment
4. Cut back on transfers boosts the most employment + positive
effect on budget deficit
5. In a small open economy, low taxes on capital and stable
economic policy leads to increased capital inflows and GDP
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28. The broad research agenda Taxation and labour supply Empirical findings The model Simulation results Conclusions
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Specific conclusions
1. Tax cuts between 2008-2010 and 2010-2012 have very
different long-run effects on GDP and employment.
2. Positive employment effects of the 2010-2012 package come
exclusively from the cuts in unemployment benefit (Caveat!)
3. An increase in the risk premium on Hungarian real investment
of 50 basis points has the potential to wipe out any positive
growth effect of the 2010-2012 package
4. Making the “crisis taxes” permanent is equivalent to an
increase in the risk premium between 25-50 basis points
5. Measures in both periods increased inequality, but the second
period more. In terms of the Gini index, Hungary may move
from a low-inequality state to close to the EU median.
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