Optimal Marginal Income Tax Reforms: A Microsimulation Analysis

John Creedy & Nicolas Herault
Authors registered in the RePEc Author Service: John Creedy and Nicolas Hérault

No 1080, Department of Economics - Working Papers Series from The University of Melbourne

Abstract: Extensive research has shown that few robust results regarding the optimal tax structure are available. Moreover, the stylised models used in optimal tax analyses are not appropriate for practical policy advice. This paper proposes a method of examining optimal marginal income tax reforms using behavioural microsimulation models in which the full extent of population heterogeneity is represented along with all the details of highly complex tax and transfer systems. The approach is illustrated using the Australian microsimulation model MITTS. The results show that the marginal welfare changes for the Australian income tax structure are not symmetric with respect to increases and decreases in tax rates, largely because of the asymmetry in tax revenue changes arising from differential labour supply effects in different ranges of the income distribution. In addition, the extent of inequality aversion was found to play a much larger role in the determination of the optimal direction of rate changes than the form of the welfare metric or the specification of adult equivalence scales.

Keywords: Optimal taxation; marginal reforms; behavioural microsimulation; social welfare function; money metric utility. (search for similar items in EconPapers)
JEL-codes: D63 H21 H31 I31 J22 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2009
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Working Paper: Optimal Marginal Income Tax Reforms: A Microsimulation Analysis (2009)
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