Answer: This British Prime Minister's experience implementing tax theory showed that when politics trumps economics, the politics can actually be right.
Question: Who is Margaret Thatcher? (She believed, as economic theory held, that lump-sum taxes are optimal. Theory neglected to consider the aspect of humanity known as individual diversity.*)
*[T]he problem of optimal taxation becomes too easy: the optimal tax is simply a lump-sum tax. After all, if the economy is described by a representative consumer, that consumer is going to pay the entire tax bill of the government in one form or another. Absent any market imperfection such as a preexisting externality, it is best not to distort the choices of that consumer at all. A lump-sum tax accomplishes exactly what the social planner wants.
In the world, there are good reasons why lump-sum taxes are rarely used. Most important, this tax falls equally on the rich and poor, placing a greater relative burden on the latter. When Margaret Thatcher, during her time as the Prime Minister of the United Kingdom, successfully pushed through a lump-sum tax levied at the local level (a “community charge”) beginning in 1989, the tax was deeply unpopular. As the New York Times reported in 1990, “[W]idespread anger over the tax threatens Mrs. Thatcher's political life, if not her physical safety. And it may prove to be the last hurrah for her philosophy of public finance, in which the goals of efficiency and accountability take precedence over the values of the welfare state” (Passell, 1990). The tax was quickly revoked, and not coincidentally, Thatcher’s term of office ended not long after.
Answer: This rate has been estimated to be zero, surprisingly, by many researchers, while some economists argue it should optimally be 50 or even 80 percent.
Question: What is the top marginal income tax rate?
Finally, the relevant elasticities are crucial for optimal marginal tax rates. While optimal tax simulations often assume a uniform elasticity, Feldstein (1995) estimated large elasticities of taxable income with respect to tax rates among high earners. Gruber and Saez (2002) subsequently estimated smaller elasticities, but their estimates also support the hypothesis that the elasticity increases with income. If high-income workers are particularly elastic in how their taxable income decreases with higher tax rates, this would imply lower optimal marginal tax rates on high incomes, all else the same. But as with the distribution of abilities and the social welfare function, there is much debate over the true pattern of elasticities by income.
All this leaves the policy advisor in an uncomfortable position. Early work, following Mirrlees (1971), assumed a shape for the ability distribution, social welfare and individual utility functions, and a pattern of labor supply elasticities that yielded clear but surprising results— declining marginal tax rates at the top of income distribution. Some recent work has yielded dramatically different results more consistent with existing policy, but many of the key assumptions are open to debate.
Answer: 29 out of 30 OECD countries have this tax, all but the United States. It is flat, taxes only final goods (and sometimes services), and tends to generate large amounts of revenue.
Question: What is the value added tax or VAT?
Moreover, 11 of the 12 OECD countries who have used a value-added tax since 1976 raised their rates over this period, and the average rate among these 12 countries increased from 15.6 percent to 20.4 percent. The only exception (France) lowered its rate only slightly from 20 percent to 19.6 percent over this period.
Combined, the increase in countries using a value-added tax and the increased rates in countries that already had a value-added tax have led to a near doubling of the share of tax revenues (on an unweighted average basis) collected by general consumption taxes in the OECD from 1960 to 2003 (OECD, 2006). Furthermore, this growth in the value-added tax has largely replaced excise taxes on specific goods, which violate either the condition that intermediate goods (like oil) should not be taxed or the condition that final goods (like tobacco and alcohol) should all be taxed alike.
All the quotes are from a new paper by Greg Mankiw, Matthew Weinzierl and Danny Yagan (which is forthcoming from a well-known econ journal). The Jeopardy-style A&Q is from your devoted blogger.
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