A Microsimulation Approach to an Optimal Swedish Income Tax

59 Pages Posted: 15 Sep 2009

See all articles by Peter Ericson

Peter Ericson

Goeteborg University - School of Business, Economics and Law; Ministry of Finance

Lennart Flood

Goeteborg University - School of Business, Economics and Law; IZA Institute of Labor Economics

Abstract

This paper follows the theory of optimal taxation and the goal is to identify a tax/benefit design that maximizes social welfare. A two stage process is proposed where the individuals preferred choice of leisure and consumption is solved in the first stage, and the second stage identifies the tax/benefit system that maximize the social welfare function. Our study deviates from the mainstream literature as the first stage is based on a static micro simulation model with behavioral responses. The behavioral responses take two different forms and use two different types of models; first binary models that describe mobility in/out from non-work states such as old age pension, disability, unemployment, long term sickness, and second models that describe change in working hours and welfare participation. Compared to the current Swedish income tax, our results suggest that increased basic deduction and in-work tax credit in combination with a reduction of the progressive national taxes would increase welfare. We also find strong support for increased housing allowances. The reforms are financed by a tax based on the same tax base as the proportional municipal income tax.

Keywords: micro simulation, tax-benefit system, in-work tax credit reform, optimal taxation

JEL Classification: C8, D31, H24

Suggested Citation

Ericson, Peter and Flood, Lennart, A Microsimulation Approach to an Optimal Swedish Income Tax. IZA Discussion Paper No. 4379, Available at SSRN: https://ssrn.com/abstract=1472571

Peter Ericson

Goeteborg University - School of Business, Economics and Law ( email )

Box 640
SE 405 30 Goeteborg
Sweden

Ministry of Finance

Drottinggatan 21
Stockholm 10333
Sweden

Lennart Flood (Contact Author)

Goeteborg University - School of Business, Economics and Law ( email )

Box 640
SE 405 30 Goeteborg
Sweden
+46 31 773 1331 (Phone)
+46 31 773 1043 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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