The goal of this paper is to estimate the efficiency cost of one additional euro of revenue through the personal income tax system, considering its simultaneous effects on the labour market and the transport market. More precisely, we seek to derive estimates of the Marginal Excess Burden of marginal personal income tax rates in Belgium considering the subsidization of company cars. We find that taking into account of welfare losses in the transport market adds 5-7 cents to the welfare cost of an additional euro of tax revenue, compared to models that consider only the effects on the labour market. The cost of raising the top marginal tax rate rises by 28% to 58% depending on the model assumptions. As an aside, we estimate tax expenditure on the transport sector via the personal income tax system to be 1.9 billion euro. We conclude that there is scope for welfare improving by base broadening and rate cutting. The framework is applied to analyse the merits of cash-for-car proposals.
In 2012, transport related tax expenditure in Belgium are estimated to amount to 1.9 billion euro, of which 1.5 billion is due to the company car regime. This is 4.3% of personal income tax revenue. Such large subsidies strongly influence the transport market, as has been shown in previous work (Laine and Van Steenbergen, 2016a).
In this paper, we study the company car regime in Belgium in a broader context. We calculate the societal cost of an extra euro of revenue raised through the personal income tax, taking into account the negative effects on different markets that are influenced by this tax. We discuss the labour market and the transport market taken together.
Taxes cause an income loss for those people that continue to participate in the market, and cause other people to forcibly alter their behaviour or to disappear from the market altogether. Typically, the loss of the latter cannot be compensated for by simply recycling the revenue of the tax back to households. Hence, for every additional euro that is being raised, people adapt their behaviour and the efficiency cost continues to increase.
Subsidies cause a similar efficiency cost. People are stimulated to consume a good in quantities they would not purchase if they were to receive the budgetary cost in freely disposable cash income.
In the personal income tax, statutory marginal rates are for a large part responsible for influencing the behaviour of economic agents, and therefore for its efficiency cost.
If tax expenditure takes the form of deductions and exemptions, the impact of marginal rates in the personal income tax is twofold. First, they influence the labour market through the classical channel of labour supply. Rising marginal rates to finance additional revenue will decrease the reward of work, causing people to supply less hours. Second, they influence the implicit subsidy of exempted expenditure, such as company cars. By raising marginal rates, such income-in-kind becomes more attractive compared to ordinary wages, putting more cars on the road. In addition to negative labour market effects, marginal rates cause an overconsumption of cars with negative effects on the environment and congestion.
To evaluate these twin impacts, we construct empirically implementable formulas on the marginal efficiency cost of labour income taxes, in the presence of tax deductions. The model incorporates behavioural reactions on the choice of hours worked and the participation in the labour market and allows for differentiating households by income category.
Given plausible hypotheses, the additional impact on the transport market raises the efficiency cost of one euro of additional revenue through the personal income tax system by 5 to 7 cents, or an increase by 24-39% compared to models that only take the labour market impact into account. The cost of raising marginal rates for the top decile increase by 28 to 58% due to the additional impact on the transport market.
We deduce that the cash-for-car principle, which allows current beneficiaries of a company car can exchange their vehicle for cash equivalent, addresses the transport market distortion, but leaves the labour market distortion of marginal rates intact.