The Political Economy of Progressive Taxation

218 Pages·1989·19.276 MB·English

by  William A. Niskanen (auth.), Professor Dr. Dr. Dieter Bös, Professor Dr. Bernhard Felderer (eds.)

Dieter Bos . Bernhard Felderer (Eds.)
The Political
Economy
of Progressive
Taxation
With 4 Figures
Springer-Verlag Berlin Heidelberg New York
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Professor Dr. Dr. Dieter Bas, Institute of Economics, University of Bonn,
Adenauerallee 24-42, 0-5300 Bonn 1, FRG
Professor Dr. Bernhard Felderer, Department of Economics,
University of Cologne,
Albertus-Magnus-Platz, 0-5000 Cologne 41, FRG
ISBN-13:978-3-642-75001-4 e-ISBN-13:978-3-642-74999-5
DOl: 10.1007/978-3-642-74999-5
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Preface
This volume presents papers which were given at a conference of the Liberty Fund,
Washington, co-sponsored by the Carl-Menger Institute, Vienna. The conference
took place in Vienna in January 1988. All papers were subject to a refereeing
process; some of them had to be revised very extensively.
The economics of progressive taxation have been a research topic ever since
economists have dealt with the economic role of the state. Old puzzles are the
best: the theoretical underpinning of progressivity still is not fully convincing,
even after 200 years of economic research. In the present volume we succeeded
in publishing some contributions of outstanding economists which present their
visions of the topic.
Niskanen distinguishes two types of contributions of public choice analysis to
understanding and evaluating the tax and transfer system in modern economics:
the positive analysis, which examines the issue of how a tax and transfer system
would look if it were established by a government subject to majority rule; .a nd
the normative analysis, which tries to discern an optimal system of taxes and
transfers. In the normative case the author distinguishes between the "libertarian
perspective", in which each person has full rights to any property that he has
acquired legally and in which transfers are determined entirely by the preferences
of the donors, and the so-called "constitutional perspective" , in which each person
elects the rules affecting taxes without knowledge of his position in the post
constitutional distribution.
Peacock criticizes and comments on the literature on the Laffer curve and sug
gests new approaches to the subject. The paper starts with a simplified exposition
of the Laffer analysis. In reviewing the literature, one comes to the conclusion that,
within the strict confines of the Laffer analysis as depicted in many academic jour
nals, the Laffer curve is a highly suspect construction. Most contributions to the
literature accept the hypothesis that taxpayers react passively to government ac
tion. Consequently, the author proposes a framework for a public choice approach
to the Laffer problem.
Streissler, in his contribution, elaborates on the international consequences of
less progressive taxation. He argues that, given the worldwide movement towards
less progressive income taxation, the decisive factor in international trade is no
longer comparative advantage, but comparative taxation. The author is interested
in the international aspects of the relation between such factors as labor supply,
VI D. Bos and B. Fe1derer
saving and capital formation, risk taking, etc., when taxation becomes less pro
gressive. In addition, factor movements elicited between countries with less or
more progressive taxation is an important topic in this paper. Though the author
admits that theoretical answers to many of these questions are ambiguous, he suc
ceeds in finding convincing explanations for most phenomena and questions raised
by using empirical results and arguments.
Bos and Tillmann look for an income taxation scheme which leads to equitable
and fair allocations: can an income tax be defined in such a way that everyone
prefers his own position to the position of any other person? If only individual
consumption-labor bundles are considered, regardless of the individual abilities,
it is impossible to achieve an equitable state by means of an income tax. If, on
the other hand, the individual productivities explicitly are taken into account, an
income tax always yields an equitable allocation. However, only the laissez-faire
state is equitable and Pareto optimal. Hence, the Bos-Tillmann paper implies a
rather pessimistic view of an equity-based theoretical explanation of progressivity.
Consequently, the authors hint at second-best solutions, where the equitability
postulate can be re-interpreted as a postulate of self-selection.
Swoboda and Steiner integrate various recent branches of the literature on
entrepreneurial behavior and taxation. The effects of progressive taxation on the
risk-taking of entrepreneurs are very indeterminate. Whether progressive taxation
enhances or hinders risk-taking depends essentially on the utility function of the
individual. Contrary to widespread intuition, flat (linear) taxes are most efficient
only under special assumptions. According to the authors, further developments
of the principal-agent theory could solve the open problems mentioned above.
Finally, this volume contains two papers which deal extensively with the
shadow economy. Neck, Schneider, and Hofreither first present a model in the
Allingham-Sandmo tradition. The "rational tax evaders" decide on the supply
of underground labor and the demand for underground goods. Under particular
assumptions the households' supply of underground labor is increased by higher
marginal income tax rates. The firms' demand for underground labor and the
supply of underground goods depend positively on the indirect tax rate. Whether
official sector wage rates have a positive or negative influence on the equilib
rium amount of underground labor depends upon whether demand or supply side
changes dominate.
In their second paper, Schneider, Hob-either, and Neck deal with a small
macroeconomic model of the Austrian economy. Their estimation of the shadow
economy applies the currency-demand approach, which is based on the assumption
that shadow transactions are undertaken in the form of cash payments. A hidden
Preface VII
economy, therefore, generates excess demand for currency which can be used to
deduce the size of the shadow transactions. In their econometric model the authors
show that easing the direct tax burden effectively reduces the shadow economy. A
reduction of indirect tax rates has a more modest influence on the relative size of
the shadow economy.
Dieter Bos
Bernhard Felderer
Table of Contents
Preface (D. Bos and B. Felderer) v
Progressive Taxation and Demographic Government:
A Public Choice Analysis (W.A. Niskanen) 1
Progressive Taxation: Models and Policies (Ch. Kirchner) 19
The Rise and Fall of the Laffer Curve (A. Peacock) 25
On the Irrelevance of the Laffer Curve (C.-A. Andreae and Ch. Keuschnigg) 41
The International Consequences of Less Progressive Taxation (E. Streissler) 43
Tax Reforms and International Mobility (L.B. Yeager) 71
Equitability and Income Taxation (D. Bos and G. Tillmann) 75
A Political Philosopher's View of Equitable Taxation (J. GJ;ay) 101
An Economists' View of Equitable Taxation (D. Bos and G. Tillmann) 107
Capital Markets, Entrepreneurship and Progressive Taxation
(P. Swoboda and P. Steiner) 111
Taxing Entrepreneurs: Models and Reality (T. W. Hazlett) 145
The Consequences of Progressive Income Taxation for the Shadow
Economy: Some Theoretical Considerations (R. Neck, F. Schneider,
and M.F. Hofreitber) 149
The Consequences of Progressive Income Taxation for the
Shadow Economy (F.A. Cowell) 177
The Consequences of a Changing Shadow Economy for the "Official"
Economy: Some Empirical Results for Austria (F. Schneider,
M.F. Hofreitber, and R. Neck) 181
Notes on Taxes and Tax Evasion in Austria (G. Lehner) 213
Addresses of Authors 219
Progressive Taxation and Democratic
Government: A Public Choice Analysis
William A. Niskanen, Washington, D.C., USA
Introduction
Public choice analysis provides two important types of contributions to under
standing and evaluating the tax and transfer systems in contemporary economies.
Positive public choice analysis addresses such questions as "What are the char
acteristics of the tax and transfer system that are likely to be selected by con
temporary governments?" Normative public choice addresses such questions as
"What characteristics of a tax and transfer system would commend unanimous
consent, given the conditions and preferences of each person affected?" A com
parison of the results of these two types of analyses, in turn, provides interesting
insights about the direction of desirable changes in the tax and transfer system
and about the effects of alternative constitutional rules on the behavior of govern
ments. This paper summarizes the major contributions of public choice analysis
to these types of questions and illustrates these contributions with some examples
that are roughly representative of the our contemporary economic and political
systems. All of these major contributions a.nd some of the examples were devel
oped by other scholars. My own role is limited to developing the implications of
these contributions for the specific issue of the structure of the tax and transfer
system and some examples to illustrate these issues.
A Positive Analysis of Taxes and Transfers
Contemporary economic and political systems use two types of currencies - money
and votes. Since the distributions of money and votes among the population are
quite different, one should expect a "market" to develop in which some groups use
D. BOs and B. Felderer (Eds.)
The Political Economy of Progressive Taxation
© Springer-Verlag Berlin Heidelberg 1989
2 William A. Niskanen
their relative surplus of votes to acquire money and other groups use their relative
surplus of money to influence votes.! The outcomes of this market, in turn, depend
on whether the effective constitution permits such transactions, the decision rules
in this market, and the relative distributions of money and votes. This paper
addresses only one side of this market, the use of votes to acquire money. Some
other paper will have to summarize the similarly complex process by which groups
use money to influence votes. Actual tax and transfer systems, in turn, will reflect
the net outcome of these two processes.
A Simple Example of Majority Rule
Consider the following example to illustrate the process of using votes to acquire
money:
- A polity consists of five groups, designated as A, B, C, D, and E.
- Each group has an equal number of votes.
The level of income before taxes and transfers of these groups is, respectively,
10, 20, 30, 40, 50. (This corresponds roughly to the level, and distribution of
income per worker before taxes and transfers in the United States.?
- Each group votes to maximize its own income after taxes and transfers. (In
other words, no group has any net benevolence or malevolence with respect
to other groups.)
- Any group may propose a change in taxes and transfers, and any proposal
must be approved by a minimum of three of the five groups.
- And, for this example, the level of income before taxes and transfers in each
group is given - in other words, is independent of the characteristics of the
tax and transfer system.
1 Several related activities also affect this market. Groups with a relative surplus of votes
will attempt to constrain the use of money to iufiuence votes. And groups with a relative surplus
of money will attempt to discredit the processes by which people use votes to acquire money. In
the spirit of truth in advertising, may I acknowledge that the Cato Institute is financed by this
second type of group.
2 A careful reader will observe that the median income in this example is the same as the
mean iucome. For all observed income distributions, in contrast, the median income is lower than
the mean income. Since voting is a positive function of income, however, the median income of
voters appears to be close to the mean iucome of the population.
Progressive Taxation and Democratic Government 3
Table 1 illustrates a representative set of outcomes for the conditions specific
to this example.
Table 1: The Distributional Effects of Majority Rule
Group
A B C D E
Before Taxes and
Transfers Income Transfer Share (%)
10 20 30 40 50 0.0
After Taxes and
Transfers
Coalition
1. ABC 16 26 36 36 36 12.0
2. ADE 20 20 30 40 40 6.7
3. ABC 24 24 34 34 34 14.7
4. CDE 10 20 40 40 40 6.7
5. ABE 13.3 23.3 30 40 43.3 4.0
6. ABC 17.3 27.3 34 34 37.3 13.1
etc.
This set of outcomes reflects the standard results of this type of analysis. The
more important lessons from this type of analysis are the following:
1. The effective coalition on each proposal will be the minimum necessary
coalition for approval, and the net gains to each group in the effective coalition
will be equal.
2. All transfers will be received by one or more of the lower-income groups,
and all taxes will be paid by one or more of the higher-income groups.
3. There is no dominant coalition, however, on taxes and transfers. In other
words, some new coalition can gain approval to replace any existing distribution
of taxes and transfers. 3
4. Moreover, the level and distribution of taxes and transfers differs sub
stantially among the set of viable proposals. Among the limited set of proposals
described in Table 1, for example, the tax and transfer share of total income varies
from 4 percent to 14.7 percent, and the amount of transfers to the lowest income
groups varies from 0 to 140 percent of their income before transfers. (For compar
ison, it is interesting to note that total transfer payments in the United States are
3 The possibility that majority rule may lead to cycles was apparently first discovered by
Condorcet in 1785. For an efficient summary of the conditions that lead to such cycles, see
Mueller (1979), pp. 38-49.