Taxation

Krishna Pendakur
Department of Economics, SFU
 Outline
• Some Definitions
– Marginal vs average
– Tax bases
– Laffer curves/marginal cost of public funds
• Efficiency cost of taxation
– Progressivity
• Comparison over time and space
 Deficit Accounting
• Budget balance = revenue – spending + actuarial
gains/losses
– Interest on debt is included in spending
– Actuarial changes are grouped with expenses
• E.g., increased projected cost of federal employee pension
• Mostly about projections over time, so should tend to zero if
projections are good
• Deficit for negative budget balance; Surplus for positive
budget balance.

• Debt is the sum of all deficits over time;

• Debt today = Debt last year + deficit today + asset change
 Deficit Accounting

• Table A1.5, 2022/23 Federal Budget

– revenue = 437.3B
– Spending (aka: expenditure) = 470.4B
• Comprised of 473B program expenditures and 24.9B public debt charges
(interest cost)
– Actuarial gains/losses = - 9.8B
– Budget balance = 437.3B - 470.4B – 9.8B = - 43.1B
• 43B deficit must be borrowed, so it increases debt from last year.

• Debt = last year’s debt + this year’s deficit + assets chg

• 1,180.7B = 1,134.5B + 43.1B + 3.1B
 Govt Must Pay for What It Spends
• If government spends more than it collects in
tax revenues, it must borrow the difference.
• This borrowing increases public debt.
• Public debt accrues interest.

• So, if you want to spend more, you must

– Either, raise tax revenue, or
– Borrow it, and pay it back---with interest---later
 Spending vs Revenue
• It is important to think of tax and expenditure
policy together
– Accounting identities:
• expenditure=revenue+deficit
• debt = last year’s debt+deficit
• with stable debt, expenditure=revenue
• so, if you want high expenditure, you must have high
revenue.
• Expenditures are very progressive. Thus, if you
cut expenditures, you are cutting from the
progressive side of the system. More later on.
 Personal Income Tax Rates
• personal income taxes are income taxes paid
by people (not firms/corporations).

• Distinct from commodity taxes, property taxes

 Fun Fact
• The bottom tax bracket charges 0% and has an
upper limit of $15,000 in 2023. Above that,
the tax rate is 20.06%
• Suppose you have already earned $14,900,
reported to CRA.
• Suppose I have a grant that expires and offer
to pay you $1,000 for no work. The income
will be reported to CRA
• Should you take the free money?
Personal Income Tax Rates in BC, 2023
The Personal Amount, 2023
 Marginal Vs Average Tax Rates
• The average tax rate is the total tax paid divided
by the total income.
– This rate depends on the income level.
• The marginal tax rate is the tax paid on an
additional dollar of income at a given income
level.
– At an income of $50k, the marginal tax rate is 22.7%.
– For all income levels above $241k, the marginal tax
rate is 53.5%.
 Tax Progessivity
• We say that a tax system is progressive if the
average tax rate rises with income.
• We say that it is regressive if the average tax
rate falls with income.

• We say that a tax system is “more progressive”

if the (positive) response of tax rates to
income is higher
Public Expenditures are Progressive
• Most public expenditures are on publicly provided
private goods that are given in roughly the same
quantity to each person:
– Publicly funded health insurance is about $5000/person
– Publicly funded K-12 and post-secondary is about $9000
/student
• If they were cash, they would be negative taxes.
• These would be progressive:
– large negative fractions of income for poor households
– small negative fractions for rich households.
 Tax Bases: Income Taxes
• We tax many different types of things
• Income
– Personal
• Labour income
• Capital income (dividends from stocks, interest from
bonds)
• Rental income
• Capital gains/losses (change in value when sold)
– Corporate
• Accounting profits of firms
 Personal Income Tax
• Personal income taxes are progressive
– The marginal tax rate rises with income.
– Therefore the average tax rate rises with income.
• Personal taxes are filed at the individual level,
meaning that, for the most part, only an
individual’s income matters (not their family or
household income).
• Personal taxes also depend on people’s
characteristics (are they disabled? Do they have
children? Etc).
 Tax Credits
• A tax credit reduces your tax bill, for some specific
reason (e.g., you have children, you are disabled, etc)

• A refundable tax credit can reduce your tax bill below

zero: government can pay you.
– The Canada Child Tax Benefit is a refundable tax credit.

• A non-refundable tax credit can reduce your tax bill,

but not below zero.
– The personal amount is a non-refundable tax credit.
 Tax Benefits: Child Benefits
• Child benefits cost a lot
• https://data.oecd.org/chart/4Ofl
• Canada Child Tax Benefit 2022 (for workers and non-workers)
• $6,997 per year ($583 per month) for each eligible child under the age of six
• $5,903 per year ($492 per month) for each eligible child aged 6 to 17
• The amount of CCB you get when your adjusted family net income (AFNI) is
over $31,711. The reduction is calculated as follows:
• families with one eligible child: the reduction is 7% of the amount of [income] between
$31,711 and $68,708, plus 3.2% of the amount of [income] over $68,708
• About 6m children receive it. Total tax benefit is around $26b per year (Table
A1.6 of Federal Budget)
• BC Child Opportunity Benefit
• $133 per month for the first child (hh income <25k); $58 per month (<80k)
• USA Earned Income Tax Credit 2020 (for workers only)
• $3,584 with one qualifying child. $6,660 with three or more qualifying
children. tax-back rate of 21% above $17k income
Source: Smith, R. 1995. “The Personal Income Tax…” Canadian Tax Journal 43(5), pp 1055
Corporate Income Tax
 Corporate Tax Rates Worldwide

Source: https://home.kpmg/ky/en/home/services/tax/tax-tools-and-resources/tax-rates-online.html
 Tax Bases: Payroll Taxes
• Payroll taxes
– Little boxes on your T-slip
– Employment Insurance
– Canada Pension Plan
• Employer contributions
• Employee contributions
• Ceilings and regressivity
CPP and EI Payroll Taxes
 Tax Bases: Consumption and Property
• Consumption
– Goods and Services Tax (GST) 5%
• Value added tax
• On everything but food, shelter, medical
– Provincial Sales Tax (PST) 7%
• Final sales tax
• On goods (not services), except food and medical

• Property
– Provincial property tax
• About 0.25% of value in Vancouver
– Progressive property taxes in BC:
• 0.20% extra on assessed value $3-$4m; 0.40% extra on assessed value
exceeding $4m.
– Quiz: what’s the property tax on a $10m home?
Progressive Property Tax
Estate Taxes in Canada and the USA
• Canada
– 0% estate tax; 1.4% probate fee
• USA:
– federal estate tax that applies at a rate of 40% on
individual estates over $5.49m or $10.98m for
married couples.
 Figure 11.8. The annual inheritance flow
as a fraction of household disposable income, France 1820-2010
Annual value of inheritance and gifts (% household disposable income) 40%

36% Economic flow (computed from national wealth

estimates, mortality table and age-wealth profiles)

32%
Fiscal flow (computed from bequest and gift tax data,
incl. tax-exempt assets)
28%

24%

20%

16%

12%

8%

4%

0%
1820 1840 1860 1880 1900 1920 1940 1960 1980 2000
Expressed as a fraction of household disposable income (rather than national income), the annual inheritance flow is about 20%
in 2010, i.e. close to its 19th century level. Sources and series: see piketty.pse.ens.fr/capital21c.

Source: Piketty, T. 2013. Capital in the 21rst Century

 Figure 14.2. Top inheritance tax rates, 1900-2013
100%

90% U.S.
Top marginal tax rate applying to the highest inheritances

80% U.K.

70% Germany

60% France

50%

40%

30%

20%

10%

0%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
The top marginal tax rate of the inheritance tax (applying to the highest inheritances) in the U.S. dropped from 70%
in 1980 to 35% in 2013. Sources and series: see piketty.pse.ens.fr/capital21c.

Source: Piketty, T. 2013. Capital in the 21rst Century

 Tax Bases: Other
• CO2
– Currently (2023) $65/ton in BC (e.g., 17.55 cents per litre)
– Federal Policy: “The fuel charge rates reflect a carbon pollution
price of $65 per tonne of carbon dioxide equivalent (CO2e) in
2023…which will rise by $15 per tonne annually to reach $170
per tonne in 2030.”
– https://www.canada.ca/en/department-
finance/news/2021/12/fuel-charge-rates-for-listed-provinces-
and-territories-for-2023-to-2030.html
• Sins (aka: excise taxes)
– Tobacco ($6.50 per pack); alcohol (roughly 100%)
• Luxuries (about zero)
• Estates/bequests (about zero)
 Historical Personal Income Tax Rates, Canada
Top Rate in BC in 2023 is 53.5% on income above $240,000

Source: Smith, R. 1995. “The Personal Income Tax…” Canadian Tax Journal 43(5), pp 1055
Tax Progressivity in Canada
 Tax Progressivity in the USA

Source: Piketty, T and E. Saez. 2006. “How Progressive is the US Federal Tax System?”
NBER Working Paper 12404
 Figure IX Average Tax Rates across the Distribution
The top panel depicts the macroeconomic tax rate (total taxes to ...

Q J Econ, Volume 133, Issue 2, May 2018, Pages 553–609, https://doi.org/10.1093/qje/qjx043

The content of this slide may be subject to copyright: please see the slide notes for details.
 Open MOBLAB
• You are either a buyer or seller of oranges
• Sellers have costs of production starting at 50
cents
• Buyers have valuations that differ across
buyers
• Sellers get: price-cost (-seller tax)
• Buyers get: valuation-cost (-buyer tax)
• Game 1: buyer tax
– Buyer gets: value – price – tax
– Seller gets: price – cost
• Game 2: seller tax
– Buyer gets: value – price
– Seller gets: price – cost – tax
• Tax is 50c per unit.
 Oranges
• Taxes
– On sellers
– On buyers
• What do taxes on oranges do to prices and
quantities?
• Do taxes induce inefficiency?
• What’s the Pareto Improvement?
 Taxation: Behavioural Response
• When we tax something, people want to do it
less.
– Tax income: people are less willing to work for income
– Tax consumption: people would rather save or invest
– Tax firms: firms would rather avoid/evade/leave/pass
costs through to consumers
– Tax land: there’s not much response possible here---
that’s why economists like land taxes.
– Tax CO2 emission: people want to emit less---that’s
the point!
Laffer Curve
 Laffer Curve Napkin Dispute
• NYT Oct. 13, 2017 re: Napkin in National
Museum of American History
• In an interview, Mr. Laffer, said it was most
likely a keepsake created a few years later.
– It is cloth, while the original napkin was paper. It is
dated 9/13/74, while the original meeting took
place after the November 1974 midterm
elections. And it is inscribed to Donald H.
Rumsfeld, then Ford’s chief of staff. Mr. Laffer met
with Dick Cheney, Mr. Rumsfeld’s deputy.
Laffer Curve
 Marginal Cost of Public Funds
• Think about income taxation (for the moment).
• If you tax income, people have less incentive to:
– Report income
– Earn income
– These together determine e the response of the reported
income to the tax rate
• MCPF: Suppose the response is all about earning. Then
a dollar of revenue “costs” the dollar plus the number
of dollars of lost earnings.
– The 1/slope of the Laffer curve tells you how fast the tax
base shrinks as you increase the tax base.
– MCPF is 1+1/slope of the Laffer curve
MCPF in Canada
 MCPFs by tax base
• Firms respond to corporate tax rates a lot,
especially with mobility
• People respond to income taxes somewhat
• People don’t respond very much to
consumption taxes
 Other Evidence on MCPF
• labour and capital income
• reported tax bases deriving from the one percent decline a lot
when we try to tax them more. (Milligan and Smart 2015).
• Top of the Laffer curve on personal income is about 60% in
Canada (Veall 2013), 80% in the USA (Saez et al)
• Corporate taxation is even tougher, especially for
Provinces/States. (e.g., Dahlby and Ferrede 2011).
• Nordic countries don’t have high corporate taxes. They instead
tax consumption and personal income.
• Property taxation
• Property tax base is not mobile.
• Can be progressive
• very low rates in Canada
 Taxes and Deadweight Loss
• Taxes cause lower quantities to be traded.
• Deadweight loss: the surplus lost to buyers
and sellers due to fact that the traded
quantity differs from the optimal quantity
(which would obtain in simple/perfect
markets).
– Surplus is the difference between the cost of
production and the price (for sellers) plus the
difference between the value and the price (for
buyers).
 Taxes, Behaviour and Economic Loss
• Taxes may affect behaviour of traders.
• If so, they reduce the quantity traded.
• This in turn eliminates some of the gains from
trade.
– Only the buyers who really really want the good buy
it, and only the sellers who can produce it really really
cheaply sell it.
– Buyers who only somewhat want it don’t buy it, and
forgo that surplus. Sellers, similarly.
• This is the economic loss from taxation.
 Deadweight Loss in the Orange Game
• When there was a tax, some transactions that
had gains from trade didn’t happen.
• If the tax was 50 cents, only transactions with
more than 50 cents of gains from trade
actually happened.
• Transactions with less than 50 cents of gains
from trade didn’t happen. These lost
transactions are the deadweight loss.
 Income Tax Rates:
Saez, Slemrod and Giertz
• What tax rate maximizes revenue from the rich?
– Top of the Laffer Curve. How do we estimate it?
• Mirlees (1971) shows the optimal top tax rate if rich people have
zero marginal utility of net income:
t=1/(1+ea)
– where e>=0 is the elasticity of average top-end income wrt to the net
income rate (that is, 1-tax rate) (e=0 implies no behavioural response
to tax rate),
– and a>1 is the Pareto parameter measuring how long the right-tail of
the distribution is. The closer is a to 1, the more inequality.
• Let r = a /(a – 1) is the constant ratio of the average income above any
threshold to the threshold itself. E.g., if a is 1.5, a /(a – 1) = 3. Then, the
average income of all those with income above $500,000 will be $1.5 million
and the average income of all those with income above $2 million will be $6
million. Veall (2013) says a for Canada is around 2. e is around 0.25-0.50.
• If e or a is high, then the revenue-maximizing tax rate is low.
 Optimal Tax
• According to Mirlees, the best tax rate is the
revenue-maximizing tax rate
• The revenue-maximizing tax rate is higher if e, the
response to taxation, is lower.
• The revenue-maximizing tax rate is higher if a, the
amount of equality, is lower.
– Lower equality means more very rich people who,
according to Mirlees, we can take money from
without affecting them much.
• Mirlees approach: we have a lot less equality, so
we should raise the tax rate.
Top End Responses (e)
Top End Responses (e)
e is hard to measure
maybe e is in [0.2,0.6]
Veall: e matters a lot
 Optimal Top Income Tax Rates
• The bottom line depends on how responsive the tax
base is. If it is mobile, then it is more responsive.
• Saez et al: for the USA, maybe 80%
– The USA is pretty closed
• IFS: for the UK, probably a bit under 50%
– The UK is (was) pretty open
• Veall: for Canada, 50%-60%
– Canada is on the open side
• 4% point tax increase in 2016 on top 1% incomes resulted in $1.2b
of extra revenue.
• e is about 0.5 (CD Howe).
• You get about 1/3 of the revenue that you would without
behaviour change.
 How do we tax billionaires?
Figure 12.2. Billionaires as a fraction of global population and wealth 1987-2013
1.6% 40

Total wealth of billionaires as a fraction of

1.4% aggregate private wealth (left-hand scale) 35

1.2% Number of billionaires per 100 million adults 30

(right hand scale)

1.0% 25

0.8% 20
,

0.6% 15

0.4% 10

0.2% 5

0.0% 0
1987 1990 1993 1996 1999 2002 2005 2008 2011
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aggregate&private&wealth&rose&from&0.4%&to&1.5%.&Sources&and&series:&see&pikeFy.pse.ens.fr/capital21c.&&