Combining Microsimulation and Optimization to Identify Optimal Flexible Tax-Transfer Rules

39 Pages Posted: 1 Jun 2020

See all articles by Ugo Colombino

Ugo Colombino

University of Turin - Department of Economics

Nizamul Islam

Luxembourg Institute of Socio-Economic Research (LISER)

Abstract

We use a behavioural microsimulation model embedded in a numerical optimization procedure in order to identify optimal (social welfare maximizing) tax-transfer rules. We consider the class of tax-transfer rules consisting of a universal basic income and a tax defined by a 4th degree polynomial. The rule is applied to total taxable household income. A microeconometric model of household, which simulates household labour supply decisions, is embedded into a numerical routine in order to identify – within the class defined above – the tax-transfer rule that maximizes a social welfare function.We present the results for five European countries: France, Italy, Luxembourg, Spain and United Kingdom. For most values of the inequality aversion parameter, the optimized rules provide a higher social welfare than the current rule, with the exception of Luxembourg. In France, Italy and Luxembourg the optimized rules are significantly different from the current ones and are close to a Negative Income Tax or a Universal basic income with a flat tax rate. In Spain and the UK, the optimized rules are instead close to the current rule. With the exception of Spain, the optimal rules are slightly disequalizing and the social welfare gains are due to efficiency gains. Nonetheless, the poverty gap index tends to be lower under the optimized regime.

Keywords: empirical optimal taxation, microsimulation, microeconometrics, evaluation of tax-transfer rules

JEL Classification: H21, C18

Suggested Citation

Colombino, Ugo and Islam, Nizamul, Combining Microsimulation and Optimization to Identify Optimal Flexible Tax-Transfer Rules. IZA Discussion Paper No. 13309, Available at SSRN: https://ssrn.com/abstract=3614256

Ugo Colombino (Contact Author)

University of Turin - Department of Economics ( email )

Via Po, 53
Torino, 10124
Italy

Nizamul Islam

Luxembourg Institute of Socio-Economic Research (LISER) ( email )

11, Porte des Sciences
Campus Belval – Maison des Sciences Humaines
Esch-sur-Alzette, L-4366
Luxembourg

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