Reforming the individual income tax in Spain

Abstract

Can the Spanish government generate more tax revenue by making personal income taxes more progressive? To answer this question, we build a life-cycle economy with uninsurable labor productivity risk and endogenous labor supply. Individuals face progressive taxes on labor and capital incomes and proportional taxes that capture social security, corporate income, and consumption taxes. Our answer is yes, but not much. A reform that increases labor income taxes for individuals who earn more than the mean labor income and reduces taxes for those who earn less than the mean labor income generates a small additional revenue. The revenue from labor income taxes is maximized at an effective marginal tax rate of 51.6% (38.9%) for the richest 1% (5%) of individuals, versus 46.3% (34.7%) in the benchmark economy. The increase in revenue from labor income taxes is only 0.82%, while the total tax revenue declines by 1.55%. The higher progressivity is associated with lower aggregate labor supply and capital. As a result, the government collects higher taxes from a smaller economy. The total tax revenue is higher if marginal taxes are raised only for the top earners. The increase, however, must be substantial and cover a large segment of top earners. The rise in tax collection from a 3 percentage points increase on the top 1% is just 0.09%. A 10 percentage points increase on the top 10% of earners (those who earn more than €41,699) raises total tax revenue by 2.81%.

Optimal Progressivity of Personal Income Tax: A General Equilibrium Evaluation for Spain

“…A different question is what tax progressivity would lead to the maximization of income tax revenues, i.e., calculating the income tax Laffer curve. In this sense, Guner et al (2020) estimate, at the individual level (not at the household level, as it is done in this work), that the revenue-maximizing income tax progressivity would be τ = 0.19. Bearing in mind that income tax progressivity is somewhat higher for individuals than for households (due to the compensation of higher incomes of the principal earner with lower incomes of the rest of the earners), one could think that revenue-maximizing income progressivity at the household level could fall within the vicinity of τ = 0.15.…”

“…Including this linear specification for remaining taxes could act as a consumption tax. This makes the choice of optimal progressivity more robust, since if consumption tax is not taken into account the optimal progressivity that the model finds can vary significantly, as argued by Guner et al (2020). Therefore, to specify the model economy household income tax function, a total of three parameter values must be chosen.…”

“…More specifically, by focusing on research works that are similar to the one presented in this paper and that try to evaluate fiscal reforms in the Spanish economy through macro-micro models, one can observe that the disparity in the values of the Frisch elasticity of labor supply is also a common element. For instance, Guner et al (2020) set the Frisch elasticity of labor supply to 0.5, which implies a curvature of leisure, ϕ, equal to 4.25 (when measured at the average amount of hours worked). On the other hand, Pijoan-Mas and González Torrabadella ( 2006) and Díaz-Giménez and Pijoan-Mas ( 2019) estimate in their model economies that the elasticity of the intertemporal substitution of labor is around 1.8, which would translate into curvatures of consumption of ϕ = 1.15.…”

“…Viegas and Ribeiro (2015) attempt to characterize the Spanish debt consolidation process in order to assess its effects on economic inequality and welfare. And finally, Guner et al (2020) uses a life cycle model to evaluate the impact on fiscal revenues of changes in the progressivity of personal income taxes in Spain. The study herein presented is closely related to that research, but the focus in the present work is on the welfare implications of the reforms.…”

Tax Planning in Personal Income Tax: A Systematic Literature Review

“…These models will assist tax offices in making the best decisions possible regarding the course of action to take in order to combat tax fraud. Guner et al (2020) aimed at ascertaining whether if Spanish government generate more tax revenue by making personal income taxes more progressive, he found out that such policy that raises labour income taxes for people who make more than the average wage and lowers them for people who make less than that raises a limited amount of extra revenue. If marginal taxes are only increased for the wealthiest earners, the overall tax revenue is higher.…”