Tax Policy and the Economy, Volume 38

Timely and authoritative research on the latest issues in tax policy.

Tax Policy and the Economy publishes current academic research on taxation and government spending with both immediate bearing on policy debates and longer-term interest.

This volume presents new research on taxation and public expenditure programs, with particular focus on how they affect economic behavior. John Guyton, Kara Leibel, Dayanand Manoli, Ankur Patel, Mark Payne, and Brenda Schafer study the disallowance of Earned Income Tax Credit (EITC) benefits as a result of IRS audits, and find that in post-audit years, audited taxpayers are less likely than similar non-audited taxpayers to claim EITC benefits. Janet Holtzblatt, Swati Joshi, Nora Cahill, and William Gale provide new empirical evidence on racial differences in the income tax penalty, or bonus, associated with a couple being married. Haichao Fan, Yu Liu, Nancy Qian, and Jaya Wen evaluate how computerizing value-added tax transactions in China affected the tax revenue collected from large manufacturing firms. Niels Johannesen, Daniel Reck, Max Risch, Joel Slemrod, John Guyton, and Patrick Langetieg study data on the ownership of foreign bank accounts and other financial accounts as reported on income tax returns. They find that many of these accounts are in tax havens, and they discuss the impact of the Foreign Account Tax Compliance Act on tax compliance and government revenue. Louis Kaplow integrates charitable giving into an optimal income tax framework, and shows that the externalities associated with such giving are key to determining its optimal tax treatment. Finally, Roger Gordon compares caps or quantity targets on emissions with carbon taxes and points out that which one dominates can be situation-specific and depend on a number of features of the economy.

• Language: English
• Publisher: University of Chicago Press Journals
• Release date: Jun 24, 2024
• ISBN: 9780226835716

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Contents

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Front Matter

Acknowledgments

Robert A. Moffitt

Introduction

Robert A. Moffitt

Carbon Taxes: Many Strengths but Key Weaknesses

Roger Gordon

Racial Disparities in the Income Tax Treatment of Marriage

Janet Holtzblatt, Swati Joshi, Nora Cahill, and William Gale

The Offshore World According to FATCA: New Evidence on the Foreign Wealth of US Households

Niels Johannesen, Daniel Reck, Max Risch, Joel Slemrod, John Guyton, and Patrick Langetieg

Technological Adoption and Taxation: The Case of China’s Golden Tax Reform

Haichao Fan, Yu Liu, Nancy Qian, and Jaya Wen

Optimal Income Taxation and Charitable Giving

Louis Kaplow

The Effects of EITC Correspondence Audits on Low-Income Earners

John Guyton, Kara Leibel, Day Manoli, Ankur Patel, Mark Payne, and Brenda Schafer

Tax Policy and the Economy no. 38 (January 2024): i–ix.

Front Matter

© 2024 National Bureau of Economic Research. All rights reserved.

Tax Policy and the Economy no. 38 (January 2024): xi–xi.

Acknowledgments

Acknowledgments

Robert A. Moffitt

Johns Hopkins University and NBER, United States of America

This issue of the NBER’s Tax Policy and the Economy journal series contains revised versions of papers presented at a conference on September 21, 2023. The papers continue the journal’s tradition of bringing high-quality policy-relevant research by NBER researchers to an audience of economists in government and in policy positions in Washington and to economists around the country with interests in policy-oriented economic research. The papers in this issue are wide-ranging and diverse, from the tradeoffs involved in international carbon tax agreements to the effects of computerizing VAT invoices on tax revenues, from racial disparities in the income tax treatment of marriage to optimal taxation of charitable giving, as well as from new evidence on offshore wealth holdings in tax havens yielded by new IRS data to the effect of EITC Correspondence Audits on taxpayer behavior.

I would like to thank Rob Shannon of NBER for his usual expertise and organizational acumen in overseeing the logistical details, invitations, and operational aspects of the conference and to Jim Poterba for his continued assistance with the organization of the meeting. I would also like to thank Helena Fitz-Patrick for assistance in many other aspects of the conference, especially the shepherding of the papers toward final publication. And I would like to acknowledge the continued financial support of the Lynde and Harry Bradley Foundation. Finally, let me express my thanks to the authors themselves for the hard work they devoted to producing high quality papers living up to the Tax Policy and Economy standard.

© 2024 National Bureau of Economic Research. All rights reserved.

Tax Policy and the Economy no. 38 (January 2024): xiii–xvii.

Introduction

Introduction

Robert A. Moffitt

Johns Hopkins University and NBER, United States of America

The six papers in this issue of Tax Policy and the Economy are all directly related to important issues concerning US taxation and transfers.

In the first paper, Roger Gordon examines the proposed use of a carbon tax, to be set by international agreement, as a means of limiting global warming. Economists broadly regard such a tax as more efficient than the type of quantity caps on emissions specified in the past Kyoto and Paris international agreements. Gordon argues that there are several drawbacks to such use of a carbon tax. Any tax sufficient to internalize global externalities will far exceed the rate that a country would choose on its own to internalize domestic externalities from extra CO2 emissions. Even if obliged by treaty to maintain such a high tax rate, Gordon shows that any country has an incentive, given domestic considerations, to undermine the resulting excess abatement through a wide variety of other government policies. Many of these policies would be difficult to detect or prevent. Quantity targets, in contrast, directly constrain total emissions. A second problem with use of a carbon tax, given a presumed international objective to put a cap on the extent of global warming, is the high inherent uncertainty in the effects of any given carbon tax rate on global emissions. A quantity cap, in contrast, specifies global emissions, though still leaves the inherent scientific uncertainty concerning the link between emissions and the extent of global warming. Another advantage of setting quantity caps is that the pattern of these caps can be adjusted across countries to assure broad participation in any international agreement, whereas a uniform carbon tax rate can leave some key countries, particularly those with large fossil fuel industries, as net losers from an agreement.

In the second paper, Janet Holtzblatt, Swati Joshi, Nora Cahill, and William Gale conduct an investigation of racial disparities in the treatment of marriage in the federal income tax. The authors note that, although the income tax code does not refer to race, provisions in the code create disparities by race when factors that affect taxes are correlated with race. They study this issue in the context of racial differences in marriage patterns that affect taxes, extending the extensive literature on marriage bonuses and penalties in the income tax to the issue of race. Black and White individuals have different rates of marriage, different income distributions, and different rates of the presence of children, all of which interact to affect tax liability. Using eight waves of the Survey of Consumer Finances from 1988 to 2019, Holtzblatt et al. produce several important findings. They find that Black couples face higher tax costs of marriage than White couples. Controlling for family income, the authors find that penalties are more prevalent for Black couples than for White couples and comprise a higher share of income. In addition, because marriage penalties in general are greater for couples with relatively similar earnings, Black couples tend to face greater penalties than White couples because they have more equal earnings. Holtzblatt et al. also find that because of the higher marriage rates of White compared with Black individuals, a greater share of White tax units face penalties than Black tax units, although this also implies that reductions in marriage penalties would benefit White individuals more than Black. Finally, the authors analyze the effect of two marriage penalty reforms, one replacing joint filing with individual filing (which would benefit those with dependents) and the other reinstating the two-earner deduction. Although both reforms would benefit all couples, a larger share of White adults than Black adults would benefit.

The third paper, by Niels Johannesen, Daniel Reck, Max Risch, Joel Slemrod, John Guyton, and Patrick Langetieg, analyzes foreign asset holdings as reported under the Foreign Account Tax Compliance Act, which newly required foreign banks, investment funds, and other intermediaries to provide to the Internal Revenue Service (IRS) information on their accounts controlled by US taxpayers. The data cover about 45,000 foreign financial institutions from 190 countries. The authors use these new data, combined with other administrative tax data, to construct new measures of the aggregate foreign financial wealth of US households as well as the distribution of this wealth over income groups. They find that about 1.5 million US taxpayers held foreign financial accounts in tax year 2018 with an aggregate value of about $4 trillion. Although only 14% of accounts were in countries usually considered to be tax havens, about half of the aggregate assets were in those areas. Their estimates imply a ratio of tax haven assets to gross domestic product of about 10% as well. The authors also examine the distribution of foreign assets over the individual income distribution, including assets held directly by individuals and indirectly via partnerships. They find a very steep income gradient. More than 60% of individuals in the top 0.01% of the income distribution hold foreign accounts, either directly or indirectly, compared with 40% for the bottom half of the top 0.1%, less than 20% for the bottom half of the top 1%, and less than 5% for the bottom half of the top 10%. Likewise, they find assets in foreign accounts, in terms of dollar values, are highly concentrated at the top of the income distribution.

In the fourth paper, Haichao Fan, Yu Liu, Nancy Qian, and Jaya Wen study the impact of computerizing value-added tax (VAT) transactions in China in 2001–2. In middle-income countries like China, VAT revenues to the government are reduced by considerable misreporting and falsification, which the administrative capacity of the tax authorities is insufficient to address. This force is particularly important in a large country like China with billions of transactions and where VAT revenues represent nearly half of government revenue. Computerization—the digital recording and electronic linking of transactions—has the potential to address this problem. Using data on firm VAT revenues and deductibles from 1998 to 2007, before and after the 2001–2 computerization, the authors conduct a difference-in-differences analysis comparing firms that were more intensely affected by the computerization with firms that were less intensely affected (intensity is measured as nondeductible inputs as a share of sales). The analysis shows that computerization increased VAT growth by more than 13.7% from 1998 to 2007; the authors estimate that the increased VAT constituted 11.7% of total 2000 VAT revenue. The effect occurred primarily through a reduction in exaggerated deductions.

In the fifth paper, Louis Kaplow addresses the extensive literature on the charitable deduction in the federal income tax. Much work has been done on that deduction, but most of it has concerned the magnitude of the elasticity of charitable giving with respect to its net-of-tax price. Kaplow instead addresses how to determine the optimal charitable deduction, building on the classic optimal taxation frameworks of Mirrlees and Atkinson-Stiglitz. Consistent with the latter, which showed that uniform commodity taxation is optimal in a basic setting with no externalities, in this framework the optimal subsidy to charitable giving (which subsidizes a particular form of expenditure) equals the Pigovian externality generated by that giving. Kaplow shows that this optimality condition does not involve the elasticity of giving with respect to its net-of-tax price, which is important for tax revenue but tax revenue does not directly enter into the optimality condition. Kaplow’s method draws on his previous work to separate the efficiency gains of tax subsidies for charitable giving from their distributional and revenue effects. This methodology involves making an adjustment to the income tax schedule to leave distribution unchanged. With that adjustment, the pure efficiency gains of allowing a deduction for charitable giving can be isolated and used to determine the optimal subsidy rate just on efficiency grounds associated with internalization of the pertinent externality.

The sixth paper, by John Guyton, Kara Leibel, Day Manoli, Ankur Patel, Mark Payne, and Brenda Schafer, studies the effects of IRS correspondence audits of filers who claim the Earned Income Tax Credit (EITC). The EITC is the country’s largest antipoverty wage subsidy program, but there are concerns about the noncompliance associated with EITC claims. The IRS attempts to detect and deter erroneous EITC claims through various methods, notably through correspondence audits: a process by which the IRS first identifies tax returns appearing to have a high likelihood of error and then contacts those taxpayers by mail, requiring them to substantiate items in their claim. The authors examine the impact of these audits on future EITC claiming and other outcomes. Using an analysis sample of filers where quasi-random variation in audit selection could be established, Guyton et al. first show that about 53% of those audited either do not respond to the audit notice (42%) or have a nondeliverable address (11%) and that only about 8% of those audited are allowed their claim. The authors note that nonresponse could be for a variety of reasons including awareness that the claim was erroneous, confusion about the audit process, or other barriers that might cause a taxpayer to forgo their claim even if it is correct. Examining the impacts on future behavior, the authors show that these EITC correspondence audits result in a 50% reduction in EITC claiming 1 year after the audit, with a gradually declining impact in subsequent years, as well as a negative impact on future rate of tax filing. The analysis also shows that children on audited returns are sometimes claimed by other taxpayers in subsequent years, and that audits are associated with a decline in reported wage income in the future, particularly in the region of earned income where potential EITC benefit amounts are the highest.

Endnote

For acknowledgments, sources of research support, and disclosure of the author’s material financial relationships, if any, please see https://www.nber.org/books-and-chapters/tax-policy-and-economy-volume-38/introduction-tax-policy-and-economy-volume-38.

© 2024 National Bureau of Economic Research. All rights reserved.

Tax Policy and the Economy no. 38 (January 2024): 1–24.

Carbon Taxes: Many Strengths but Key Weaknesses

Roger Gordon

University of California, San Diego, and NBER, United States of America

Executive Summary

There seems to be a consensus among economists in support of a carbon tax for addressing the costly implications of carbon dioxide emissions for the global climate. However, past international agreements on climate change instead specify caps on emissions (a quantity target) for each country. The aim of this paper is to explore several reasons why use of such quantity targets could dominate use of a carbon tax. For one, if a country were to impose a carbon tax at a rate high enough to correct for global externalities, this rate would far exceed the tax rate that would be in any given country’s own self-interest. The result is a strong incentive to make use of a variety of other domestic government policies to encourage greater emissions, undercutting the intended abatement under a carbon tax. A quantity target instead by construction caps emissions. Second, the paper argues that a quantity target can better ensure that global warming remains below 2°C above preindustrial levels, given the uncertainties faced regarding the response to any given carbon-tax rate. Third, the set of quantity targets set for each country can more flexibly be adjusted to ensure that most all countries benefit from participating in a global accord while still allowing efficient patterns of abatement by giving countries credit for cross-border abatement efforts.

Global warming is an increasing threat to the quality of life throughout the planet. Over the past several decades, we have seen a steady increase in global average temperatures, in some locations already pushing the limits for human habitation as well as for the survival of other species of plants and animals. These increasing temperatures are leading to much more volatile weather patterns, with increasing chances of flooding, droughts, and violent storms. Melting of the ice caps in Antarctica and Greenland are raising ocean levels, gradually leading to the inundation of heavily populated coastal areas, and will likely affect key ocean currents such as the Gulf Stream.

There has been substantial research by scientists documenting the role of carbon dioxide (CO2) in causing this global warming, work dating back at least to the 1950s.¹ More recent research by economists has gone to great effort to calculate the present value of the many social costs created per ton of current CO2 emissions through their effect on global warming (a figure now referred to as the social cost of carbon, or SCC),² work for which William Nordhaus won a Nobel Prize.³

There seems to be a consensus among economists that the most efficient way to induce emitters to take into account the social costs created by their current emissions of carbon dioxide and other greenhouse gases is through the use of a carbon tax on emissions.⁴ This tax rate should equal the SCC, thereby inducing emitters to take into account the present value of the costs their emissions impose on individuals throughout the globe, now and into the future, per ton of current emissions.⁵

For an efficient pattern of abatement, the same tax rate should be used by all countries and for all means of preventing global warming, including not only abatement of emissions of CO2 and other greenhouse gases but also sequestration of CO2.

Economists have debated how best to reach agreement on such a tax rate among countries. The challenge is that each country faces an incentive to free ride, minimizing the tax rate it agrees to impose on its own citizens while still benefiting from the abatement undertaken in other countries. Weitzman (2017a) argues that if countries need to agree jointly on one common carbon-tax rate, then they appropriately need to trade off the costs such a tax imposes on their own citizens with the benefits these citizens receive from the resulting abatement in other countries through their use of the same tax rate. He forecasts that the chosen tax rate coming out of such a political process would be very close to the SCC.

Another major hurdle is the remaining incentive on countries to free ride by not enforcing such a tax while still benefiting from the abatement done elsewhere. Here, Nordhaus (2015) recommends that countries supplement their agreement on a carbon-tax rate with an agreement on a tariff rate to be imposed on imports from any country out of compliance with the agreed tax rate. He argues that reasonable tariff rates should be sufficient to induce compliance as long as the carbon-tax rate is in the range of those implied by past estimates of the SCC.

In contrast to this consensus among economists on the use of a carbon tax to address the threats from global warming, the policies that have in fact been adopted under the United Nations Framework Convention on Climate Change, in particular, including the Kyoto Protocol and the Paris Agreement,⁶ focus instead on getting countries to commit to some specified percentage reduction in carbon emissions from a chosen base year.⁷ Although the Kyoto Protocol included some penalties for noncompliance, in practice, noncomplying countries simply withdrew from the agreement rather than pay such penalties. There were no agreed penalties under the Paris Agreement for lack of compliance, other than name and shame. Not surprisingly, then, Nordhaus (2019) finds no effect of these agreements on rates of abatement of CO2 emissions.

Supporters of a carbon tax have expressed serious reservations about this policy focus on quantity targets for abatement rather than on the appropriate carbon-tax rate. For example, Weitzman (2017b) argues that agreements are much harder to obtain when setting quantity emission targets for each country than when setting one common carbon-tax rate, helping to explain the few participants in the Kyoto Protocol and the lack of any negotiation on each country’s quantity target in the Paris Agreement. Nordhaus (2006) argues that there is no assurance that these quantity targets achieve the right level and timing of abatement, where the right level is one in which the marginal gain from abatement equals the consensus value of the SCC. He argues that quantity targets also lead to a volatile price of carbon, creating costly incentives (with no offsetting benefits) for firms to alter the timing of their emissions.⁸ The aim of this paper, though, is to raise some concerns with having international agreements commit to a particular carbon-tax rate rather than to some quantity targets.⁹

By design, a carbon-tax rate equal to the SCC should achieve the optimal level of abatement from a global perspective, implying just offsetting gains and losses at the margin from additional emissions. When emissions increase in one country, residents elsewhere clearly lose due to the marginal exacerbation of global warming. Because each country’s emissions decisions impose a negative externality on nonresidents, incentives are distorted. At the optimal tax rate, residents in the emitting country must gain by an amount just equal to these total losses to nonresidents, given that at the optimal tax rate there are zero net aggregate costs from marginal additional emissions.¹⁰

The first concern the paper focuses on is the incentives this gain from a marginal increase in emissions create for the political choice in each country over a wide range of public policies other than the agreed carbon-tax rate. To begin with, countries might try to offset such a high carbon tax with various forms of subsidies to energy production, such as a coal subsidy. Victor (2001) notes the wide range of possible taxes and subsidies affecting the energy production in any given country that can be used to offset a carbon tax and advocates some attempt to combine these into an effective net carbon tax when judging compliance with an international agreement, to prevent such direct attempts to undermine a carbon tax.

The problem, though, is much broader. Given a carbon-tax rate that far exceeds the rate that is in each country’s own self-interest, any policies that as a side effect lead to increased emissions to that extent become more attractive.¹¹ Examples could include tariff or nontariff barriers on imports of goods whose domestic production would lead to high emissions, hurdles discouraging solar-farm and wind-turbine construction, tax provisions favoring heavily emitting industries, favorable credit terms on loans to these high-emission industries (enabled, for example, through government repayment guarantees), or even just weak tax enforcement for a carbon tax.¹²

Even if some policies that lead to greater emissions end up being penalized under revised treaty provisions, there are too many policy options available for undercutting the impact of a carbon tax to become part of any feasible treaty. Side effects of the remaining policies, leading to increased emissions, could easily be sufficient to seriously undermine the effects of a carbon tax on abatement.

If instead a country commits to some quantity target for its emissions under an international agreement, the country would be left simply choosing the range of public policies that achieve this target at least cost to residents, which is the efficient outcome from an international perspective. There would be none of these second-best distortions to other policies that arise when a country commits instead to a high carbon-tax rate. This argument remains valid even if a country chooses to achieve this agreed target through use of a carbon tax.

To develop this argument, Section I will lay out the traditional theory of the use of a carbon tax to correct for the negative externalities from emissions borne by just domestic residents. Under conventional assumptions, the tax rate in theory should lead to the efficient choice for the level of this activity from the country’s perspective, eliminating any reason on second-best grounds to modify other policies due to any side effects they may have on the amount of this externality-generating activity.¹³

Section II then examines incentives when the carbon-tax rate is set much higher, to reflect negative externalities experienced worldwide. Now, on second-best grounds, the net social benefits from all other domestic policies would include an extra term reflecting the effects of these policies on revenue from the carbon tax, relative to their effects on the net loss to domestic residents from extra emissions. This section then explores a variety of policies that would be particularly responsive to these distorted incentives.

Section III examines instead the implications of a commitment to a percentage reduction in emissions as part of an international agreement. Here, by constraint, emissions are constrained by the commitments made in the international treaty, leaving other policies undistorted.

I turn next in Section IV to the implications of Weitzman’s classic paper on Prices vs. Quantities (1974), a paper directly relevant to the debate about the use of carbon taxes versus quantity targets to best achieve CO2 abatement. Weitzman’s paper focuses on the inevitable uncertainty faced when trying to use either prices or quantity targets to best approximate the ex post efficient outcome for abatement of CO2 emissions. He finds that a quantity target dominates if the marginal benefits from extra abatement vary much more over possible levels of emissions than do the marginal costs of extra abatement, and conversely.

The international discussion on global warming has focused on the large potential disruptions to the climate if the rise in global temperatures due to accumulating CO2 in the atmosphere exceeds 2°C. Implicit in this focus is a belief that the marginal benefits from abatement are substantial until there has been sufficient abatement that expected global temperatures are no higher than 2°C above past levels, even if marginal benefits could be much lower for yet further abatement. In contrast, given current technology, the marginal costs of shifting from carbon fuels to renewable sources of power such as wind