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Effects of Income Tax on Personal Savings: Evidence for Serbia. Sasa Randjelovic University of Belgrade Faculty of Economics. 2nd EUROMOD Workshop Bucharest, 12 October 2012. Outline. Motivation Theoretical framework and literature review

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effects of income tax on personal savings evidence for serbia

Effects of Income Tax on Personal Savings: Evidence for Serbia

Sasa Randjelovic

University of Belgrade

Faculty of Economics

2nd EUROMOD Workshop

Bucharest, 12 October 2012

outline
Outline
  • Motivation
  • Theoretical framework and literature review
  • Incometaxreformscenarios
  • Researchdesign, data andmethodology
  • Results
  • Concluding remarks
motivation
Motivation
  • Current income tax system in Serbia:
    • Mixed (hybrid) model, with strong scheduler component
    • Disadvantages: lack of equity (both horizontal and verical), limited redistributive effects, complicated..Reform needed and discussed
  • Income tax reform – which way to take?
    • Optimal tax theory provides different views on capital income taxation:
      • Zero capital income tax rate (Mankiw, et. al. (2009))
      • Positive rate of tax on capital income (Diamond, et. al. (2011))
  • The aim of the paper:
    • To estimate the savings response to PIT reform, by taking into account all transmitting channels (not just direct effects)
    • Contribute to the empirical literature on PIT-personal savings relationship
      • Seminal research of that kind in Serbia (and CEE?)
personal savings modelling theoretical framework and literature review
Personal Savings Modelling: Theoretical Framework and Literature Review
  • Can taxpolicyboost personal savings?
    • Absolutevs. permanentincomehypothesis
  • Taylor’s model of aggregatesavings:
    • If W*= desiredwealth, W-1=existingwealth, Y=income, S=savings, r=rate of return
  • Literature:
    • Barnheim (1999) – modestimpact of incometax on savings
    • Huizinga (2004) – elasticity of savings to incometaxrateslow
    • Peter (2006) – permanentincome-permanentconsumptionelasticityhigh (0.9)
research design and basic model specification
Research Design and Basic Model Specification
  • PIT reform triggers change to savings via:
    • Altering net-of tax rate of return to savings
    • Altering net-of tax employment income
  • Therefore, in order to capture full effects of PIT reform on personal savings it is necessary to estimate:
    • Elasticity of savings to the rate of return as well as to total income
    • Change in net return to savings due to PIT reform
    • Change in net employment income after PIT reform
  • Basic model (relying on Taylor’s approach):
data and methodology
Data and Methodology
  • Data:
    • Estimation of the basic model based on monthly data (January 2005 – December 2009, 60 observations)
    • Estimation labor demand elasticity to wage bill also based on monthly data (January 2004 – December 2008, 60 observations)
      • Change in average wage being simulated by using SRMOD
  • SRMOD – tax & benefit microsimulation model for Serbia
    • Living Standard Measurement Survey 2007
    • Sample: 5,557 households (17,375 individuals)
step 1 estimation of savings model
Step 1: Estimation of Savings Model
  • Testing for stationarity of series:
    • Standard ADF and PP tests + special tests for seasonal and structural break unit root (Hegy 12, Climao 1, etc.)
    • Conclusion: all series d=1
  • Checking for direction of causality (IR-DEP)
    • VAR(3) model esimated, based on which Granger causality test has been run
    • Conclusions: Change in IR Granger causes change in DEP (p=0,000), not opposite
  • Estimating the basic model: Engel-Granger cointegration method
  • ADF and PP tests confirm stationarity of residuals
  • IR-DEP elasticity 0.88 within range for group of countries

(0.2-4.5, Pieter (2006))

step 2 estimating effects of change in capital income tax rate on hh bank depostis
Step 2: Estimating Effects of Change in Capital Income Tax Rate on HH Bank Depostis
  • Estimationsbased on assumption of eventaxincidence (betweendeponentsand the bank)
    • …ifthisassumption is changed, the effectsalsochange
step 2 estimating effects of change in capital income tax rate on hh bank deposits
Step 2: Estimating Effects of Change in Capital Income Tax Rate on HH Bank Deposits

Estimated changes to the level of bank deposits in Serbia, depending on the percentage of tax burden born by deponents

step 3 estimating effects of change in labor income taxes on savings
Step 3: Estimating Effects of Change in Labor Income Taxes on Savings
  • Eachscenarios of PIT reformchanges the averagelabortaxwedge
  • Bymeans of SRMOD, ithasbeenesimtatedthataveragelabortaxwedgewoulddeclineby 2.01% in case of flattax, by 2.27% in case of dual incometaxandby 2.48% in case of introduction of comprehensiveincometax
  • Due to high unemployment in Serbia (>25%), effective limitation is on demand side of labor market.
    • Therefore, it is necessary to estimate labor demand response to change in labor tax wedge, in order to estimate the change in labor income due to PIT reform
step 3 estimating effects of change in labor income taxes on savings1
Step 3: Estimating Effects of Change in Labor Income Taxes on Savings
  • Labor demand modelling – macroeconomic approach
    • Main drivers: output and labor costs (Lewis (2002), Carne (2007))
  • Labor demand model specification:
    • VAC= vacancies reported to NEB, TW=tax wedge (proxy for wage), GDP=real GDP
  • Unit root tests – all series d=1, so E-G cointegration approach
    • ADF and PP tests: residuals are stationary
step 3 estimating effects of change in labor income taxes on savings2
Step 3: Estimating Effects of Change in Labor Income Taxes on Savings
  • Error-correction model applied in order to estimate short-run relationship:
step 3 estimating effects of change in labor income taxes on savings3
Step 3: Estimating Effects of Change in Labor Income Taxes on Savings
  • Estimating long run effects of PIT reform on labor demand
  • Assuming that increased labor demand would trigger corresponding increase in employment, it is expected that the these PIT reform scenarios would imply the increase in wage bill in the respective amounts
step 4 estimating total effects of pit reform on savings
Step 4: Estimating Total Effects of PIT Reform on Savings
  • When taking into account both transmission channels, the results are as follows:
  • The direct effects of change in capital income tax rate prevail over indirect effects stemming from change in labor tax wedge
concluding remarks
Concluding Remarks
  • Contribution of the paper:
    • Prividingempiricalestimate of impact of PIT on HH savings, bytakingintoaccountbothtransmittingchannels (net of tax rate of returnandwage bill)
    • Among the seminalempiricalstudiestakingthisapproach (particularly for transitioneconomies)?
  • Results:
    • Directeffects (of capitalincometax) prevailoverindirecteffects (related to laborincometax)
    • Flattaxorcomprehensiveincometaxwouldlead to decline in HH savings in Serbia (by 2.15% and 4.43% respecitvely), while in case of dual incometax the savingswould rise (by 0.2%)
    • The resultsaredependent on taxincidenceandparametrization, which is why the mainaim of the paperwas to developframework for empiricalanalysis, ratherthan to provide definiteanswer on the layout of future PIT schemein Serbia
thank you for the attention
Thank youfor the attention!

Questions or comments?

randjelovic@ekof.bg.ac.rs