The benchmark optimal income taxation model of Mirrlees (1971) finds that the optimal marginal income tax rate (MIT) is always non-negative. A key model assumption is the coincidence between social and individual work preferences. This paper extends the model to allow for differences in social and individual work preferences. The theoretical and simulation analyses show that under this model, when the government places a higher social weight on work than individuals, the optimal MIT schedule is shifted downwards, introducing the possibility for optimal wage subsidies at the bottom of the income distribution. This implies lower revenues, demogrants, and overall progressivity.
In October 2021, the MEF asked Congress for the delegation of powers to legislate on tax matters with the aim of increasing tax collections and doing so by adding progressivity to the Peruvian tax system. The initiative being developed by the MEF contains (tentatively, to date) around 40 specific measures—some administrative, others related to tax policy—that the MEF hopes will, as a whole, generate additional revenue for the treasury. The tax collection impact of quite a few of the measures (including those pertaining to the mining sector) has not been estimated, whereas the measures for which there is a calculation are estimated to bring in a little over 1 percent of GDP in revenues. Given Peru’s low level of tax collections, both relative to its own historical trends as well as those of other countries in the region, the amount expected to be collected with the proposed reform is modest. However, increasing tax collections by enhancing progressivity would appear to be the right approach.
In his comment1 on my 1983 paper,2 Acharya lists five problems relating to the use of what he calls the “Tanzi method” in estimating the size of the underground economy, problems that he considers “quite significant.” I fully agree that there are limitations to my approach, and I clearly indicated them in my concluding remarks to the paper:
The combination of large budget deficits among industrial countries and exceptionally high short-term real interest rates has rekindled interest in crowding out and its potential effects on saving, capital formation, and financial variables. This paper describes how fiscal policies that result in economic deficits alter an economy’s saving behavior. Depending on the economy’s size and degree of openness, the changes in domestic savings arising from deficit financing can produce major changes in domestic investment, real interest rates, and real wage rates. Even if pretax returns to capital and labor are unaltered by deficits, because of international capital mobility and the equalizing of factor prices through trade, economic deficits can dramatically lower an economy’s long-run welfare. This paper provides a quantitative sense of how burdensome the “burden of the debt” may be.