The case for NIT+FT in Europe. An empirical optimal taxation exercise

Summary

We present an exercise in empirical optimal taxation applied to a Negative Tax with Flat Tax reform for a sample of eight European countries: Austria, Belgium, France, Germany, Ireland, Italy, Luxembourg and the United Kingdom. Two popular approaches to empirical optimal taxation are the structural analytical approach and the non-tructural “sufficient statistics” approach. This paper presents a different approach that combines structural microeconometric modelling, behavioural microsimulation and numerical optimization. For each country, we estimate a microeconometric model of labour supply for both couples and singles. A procedure that simulates the households' choices under given tax-transfer rules is then embedded in a constrained optimization program in order to identify optimal rules under the public budget constraint. The optimality criterion is the class of Kolm's social welfare function. The tax-transfer rules considered as candidates are members of a class that includes as special cases various versions of the Negative Income Tax: Conditional (means-tested) Basic Income, Unconditional Basic Income, In-Work Benefits and General Negative Income Tax, combined with a Flat Tax above the exemption level. The analysis in most cases show that: the General Negative Income Tax strictly dominates the other rules, including the current ones; the Unconditional Basic Income policy is better than the Conditional Basic Income policy; Conditional Basic Income policy may lead to a significant reduction in labour supply and poverty-trap effects; In-Work-Benefit policy is strictly dominated by the General Negative Income Tax and by the Unconditional Basic Income. We also exemplify the possibility of identifying the mapping between the contry-specific “primitives” (social preferences, productivity, public budget constraint, labour supply elasticity and Gini coefficient) and the optimal tax-transfer rules.