In an economy which primitives are exactly those in Mirrlees (1971), we investigate the efficiency of labor income tax schedules derived under the equal sacrifice principle. Starting from a given government revenue level, we use Werning's (2007b) approach to assess whether there is an alternative tax schedule to the one derived under the equal sacrifice principle that raises more revenue while delivering less utility to no one. For our preferred parametrizations of the problem we find that inefficiency only arises at very high levels of income. We also show how the multipliers of the Pareto problem may be extracted from the data and used to find the implicit marginal social weights associated with each level of income. Keywords: Equal Sacrifice; Efficiency. J.E.L. codes: H2; D63. * This paper has circulated under the title Sacrifice and Efficiency of the Income Tax Schedule. We thank Luis Braido, Ricardo Cavalcanti, Bev Dahlby and participants at INSPER, EESP-FGV, the 2011 PET Meeting, the 67th IIPF Meeting and the 2012 ESEM Meeting for their invaluable comments. We retain full responsibility for all remaining errors. Carlos da Costa thanks the hospitality of MIT, and gratefully acknowledges financial support from CNPq. First Version: July, 2010.
JEL Code: E2, H2, H3.For many years, it has been a primary issue in tax policy whether the tax system ought to be built around income tax or consumption tax. Much of the interest in tax policy arises from the widespread belief that taxes on income and savings tend to lower long-run income by retarding the creation and expansion of firms and by discouraging workers and investments. Following this belief, Brazilian government has proposed a tax reform which, basically, replaces tax on investment and labor with tax on consumption. In this paper, we develop a dynamic general equilibrium model with heterogeneous agents to guide our quantitative assessment of the economic and distributional implications of such tax reform. The model is calibrated in such a way that it matches some selected features of the Brazilian economy. We also use the calibrated model to calculate the deadweight loss of each type of taxation and thus provide some rationality for that rearrangement in the tax system. The main result of the paper is that, even though the tax reform increases the asset accumulation, labor and output of economy, it also raises the welfare inequality as borrowing constrained individuals cannot take advantage of the drop in tax on savings.
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