Optimal Delayed Taxation in the Presence of Financial Frictions

57 Pages Posted: 25 Feb 2021 Last revised: 19 Apr 2024

See all articles by Marius Alexander Kalleberg Ring

Marius Alexander Kalleberg Ring

University of Texas at Austin - Department of Finance; Statistics Norway - Research Department

Spencer Bastani

IFAU - Institute for Labour Market Policy Evaluation; Uppsala University - Department of Economics; Research Institute of Industrial Economics (IFN); Uppsala University - Uppsala Center for Fiscal Studies; Uppsala Center for Labor Studies and Department of Economics

Date Written: February 23, 2021

Abstract

In the presence of financial frictions, the timing of cash flows matters. We apply this insight to optimal income taxation by studying a new policy: delayed taxation. Introducing a delay between the accrual and payment of income taxes provides two sources of welfare gains when some agents are borrowing constrained. First, it improves consumption smoothing for financially constrained agents. Second, it reduces the present value tax rate from the perspective of constrained agents, thereby reducing the distortionary effects of income taxation. We characterize the conditions under which marginally delayed taxation is welfare enhancing under different assumptions about the sophistication of the benchmark tax system, and we contrast the welfare gains with those achievable by offering low-interest loans or changing nominal tax rates. We then characterize optimal delayed taxation in a model calibrated to the Norwegian economy. This exercise reveals substantial welfare gains from delayed taxation. When limiting the amount the government may borrow to finance any given reform, delayed taxation materially outperforms age-dependent taxation and a policy in which the government offers subsidized loans. Finally, we empirically test the hypothesis that delayed taxation substantially reduces income tax distortions in the context of young workers in Norway, where a kinked income-contingent student debt conversion scheme replicates an income tax with delayed payments. Bunching analyses reveal elasticities that are an order of magnitude lower than those we find for a regular income tax threshold, and that increase with ex ante financial resources. Taken together, our results underscore the potential for delayed taxation to be a powerful new component of optimal tax policy.

Keywords: deferred taxation, delayed taxation, credit constraints, income taxation, household finance

JEL Classification: H21, G51, D15

Suggested Citation

Ring, Marius Alexander Kalleberg and Bastani, Spencer, Optimal Delayed Taxation in the Presence of Financial Frictions (February 23, 2021). Available at SSRN: https://ssrn.com/abstract=3791384 or http://dx.doi.org/10.2139/ssrn.3791384

Marius Alexander Kalleberg Ring (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Statistics Norway - Research Department ( email )

Kongens Gt. 6
PO Box 8131 Dep
N-0033 Oslo
Norway

Spencer Bastani

IFAU - Institute for Labour Market Policy Evaluation ( email )

Box 513
751 20 Uppsala
Sweden

Uppsala University - Department of Economics ( email )

Box 513
SE-75120 Uppsala
Sweden

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Uppsala University - Uppsala Center for Fiscal Studies ( email )

Box 513
Uppsala, 751 20
Sweden

Uppsala Center for Labor Studies and Department of Economics ( email )

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