TAX ARBITRAGE: The Simple Model

From figures such as these it is hard to avoid the conclusion that Myrdal was more right than wrong, and that the formal rate of tax progression very much exaggerated the effective one. This interpretation is given further support by a study of Hansson and Norrman (1986), which concludes that the 1982 Swedish income tax can be characterized as de facto proportional, and that the personal capital income tax led to a redistribution of income towards high-income households.

Although it is difficult to compare the extent of tax planning across countries, the Swedish experience does not seem to be unique. In their study of income tax avoidance in Germany, Lang, NohrbaB, and Stahl (1997) conclude that various legal and semi-legal tax write-off opportunities led to a dramatic reduction of the effective marginal tax rates of high-income households. In their study of tax arbitrage and tax revenue in the U.S. before TRA86, Gordon and Slemrod (1988) conclude that a move to a more uniform system of capital taxation would raise tax revenue and increase efficiency. Unlike the case of Sweden, however, they find that high-income individuals report net positive capital income.

As a point of reference, let us first assume that no arbitrage is possible. An individual with a wage rate w, facing a tax schedule T(w£\ then solves the optimization problem
where r is a vector of parameters summarizing various properties of the tax system. This is the standard formulation used in numerous empirical studies of labor supply.5 In this literature, many sophisticated techniques have been developed for taking the non-linearities of the tax schedule into account. online payday loans no credit check