Working Paper: CEPR ID: DP17970
Authors: Alessandro Di Nola; Georgi Kocharakov; Almuth Scholl; Annamariia Tkhir; Haomin Wang
Abstract: This paper studies the aggregate and distributional effects of raising the top marginal income tax rate in the presence of tax avoidance. To this end, we develop a quantitative macroeconomic model with heterogeneous agents and occupational choice in which entrepreneurs can avoid taxes in two ways. On the extensive margin, entrepreneurs can choose the legal form of their business organization to reduce their tax burden. On the intensive margin, entrepreneurs can shift their income between different tax bases. In a quantitative application to the US economy, we find that tax avoidance lowers productive efficiency, generates sizable welfare losses, and reduces the effectiveness of the top marginal tax rate at lowering inequality. Tax avoidance reduces the optimal top marginal income tax rate from 47 % to 43 %.
Keywords: Tax Avoidance; Top Income Tax Rate; Occupational Choice; Legal Form of Organization; Wealth Inequality; Incomplete Markets; Heterogeneous Agents
JEL Codes: E21; E62; H25; H26; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tax avoidance (H26) | lower productive efficiency (D24) |
| lower productive efficiency (D24) | welfare losses (D69) |
| tax avoidance (H26) | welfare losses (D69) |
| tax avoidance (H26) | optimal top marginal income tax rate (H21) |
| raising the top marginal tax rate (H29) | shift income to minimize tax burden (H22) |
| tax avoidance (H26) | reduce effectiveness of tax policies aimed at reducing inequality (H31) |
| shift income to minimize tax burden (H22) | increase in income share held by the top 1% (D33) |