Identifying Laffer Bounds: A Sufficient‐Statistics Approach with an Application to Germany

Abstract

We derive a simple sufficient-statistics test for whether a nonlinear tax-transfer system is second-best Pareto efficient. If it is not, it is beyond the top of the Laffer curve and there exists a tax cut that is self-financing. The test depends on the income distribution, extensive and intensive labor supply elasticities, and income effect parameters.A tax-transfer system is likely to be inefficient if marginal tax rates are quickly falling in income. We apply this test to the German tax-transfer system and find the structure of effective marginal tax rates likely to be inefficient in the region where transfers are phased-out.

Revealed social preferences of Dutch political parties

“…If the latter holds with equality, marginal tax rates are set at the top of the Laffer curve. Setting top rates beyond the Laffer rate is non-Paretian, since a reduction of top rates would both raise utility for top income earners, and raise tax revenue, which can be redistributed to make other individuals better off (Werning, 2007;Brendon, 2013;Lorenz and Sachs, 2016).…”

“…7 Our simulations demonstrate that the political weights are primarily driven by the distribution of gross earnings and the tax-benefit schedules, and not by participation or income effects. Third, we extend the analysis of Lorenz and Sachs (2016) by decomposing social welfare weights into their main determinants. Under some simplifying assumptions, we derive analytically how the social welfare weights change with gross earnings, much in the spirit of the analysis in Diamond (1998) on the optimal non-linear tax schedule.…”

“…Subsequently, many studies have derived social welfare weights: Petersen (2007) for Denmark, Blundell et al (2009) for single mothers in Germany and the UK, Bargain and Keane (2010) for childless singles in Ireland and the UK over several decades, Bargain et al (2014b,c) for childless singles in 17 European countries and the US, Hendren (2014) for the US, Lockwood and Weinzierl (2016) for the US over the period 1979 for the US if individuals have present bias. Finally, Lorenz and Sachs (2016) use the inverse optimal-tax method to identify Pareto-improving tax reforms in Germany.…”

Redistributive Politics and the Tyranny of the Middle Class

“…Social welfare weights therefore allow policy makers to consider reforms in a framework that does not force them to make normative judgments. Lorenz and Sachs (2016) use the inverse optimal-tax method to identify whether social welfare weights are negative and, hence, whether Pareto-improving tax reforms exist in Germany. However, none of these papers calculates social welfare weights for political parties.…”

Political preferences for redistribution in Sweden

“…The recovered weights can then be used to test the local optimality of the tax system in the spirit of the tax reform literature (see, e.g., Kleven and Kreiner 2006;Saez and Stantcheva 2016 for recent applications). See also Lorenz and Sachs (2016) for a related analysis with an application to Germany. These authors show that a given tax/transfer-system is likely to be inefficient if effective marginal tax rates quickly fall with income.…”