Malas notches

Abstract

This paper shows that the sufficient statistic approach to the welfare properties of income (and other) taxes does not easily extend to tax systems with notches, because with notches, changes in bunching induced by changes in tax rates have a first-order effect on tax revenues. In an income tax setting, we show that the marginal excess burden (MEB) of a change in the top rate of tax is given by the Feldstein (Rev Econ Stat 81(4):674–680, 1999) formula for the MEB of a proportional tax, plus a correction term. This formula applies even if there is tax evasion. These correction terms cannot be calculated just from knowledge of the elasticity of taxable income, and quantitatively, they can be large. An application to VAT is discussed; with a calibration to UK data, the MEB of the VAT is roughly three times what it would be if VAT was simply a proportional tax.

Notching R&D Investment with Corporate Income Tax Cuts in China

“…Lockwood (2018) also notes that reduced-form effects from bunching on notches are not sufficient to analyze the effects of changes in policy. This result motivates the use of a structural model for policy analysis.5Blinder and Rosen (1985) discuss selection patterns under which notches can be desirable, and Slemrod (2013) discusses administrative costs as a motivation for notches Gordon and Li (2009).…”

Welfare Analysis of Changing Notches: Evidence from Bolsa Família

“…Our key theoretical contribution relative to Lockwood (2020) is the generality of our results. Whereas Lockwood (2020) characterizes the welfare impacts of particular infinitesimal reforms to notches in a model with quasi-linear utility, one dimension of agent heterogeneity, and one choice variable, our approach allows us to bound the welfare impacts of reforms to programs with notches of any size while placing very little structure on the agent problem. 6 The remainder of the paper is organized as follows.…”

“…We overcome this need to estimate difficult statistics by focusing on welfare bounds. This paper is also related to Lockwood (2020) who observes that in the presence of notches, the sufficient statistic approach for the welfare analysis of tax systems needs to be augmented to include a correction term which captures the change in bunching at a notch in response to a tax reform. Our key theoretical contribution relative to Lockwood (2020) is the generality of our results.…”

“…This paper is also related to Lockwood (2020) who observes that in the presence of notches, the sufficient statistic approach for the welfare analysis of tax systems needs to be augmented to include a correction term which captures the change in bunching at a notch in response to a tax reform. Our key theoretical contribution relative to Lockwood (2020) is the generality of our results. Whereas Lockwood (2020) characterizes the welfare impacts of particular infinitesimal reforms to notches in a model with quasi-linear utility, one dimension of agent heterogeneity, and one choice variable, our approach allows us to bound the welfare impacts of reforms to programs with notches of any size while placing very little structure on the agent problem.…”