Piecemeal Modeling of the Effects of Joint Direct and Indirect Tax Reforms.

Capéau, B., Decoster, A. and Van Houtven, S. (2023) Piecemeal Modeling of the Effects of Joint Direct and Indirect Tax Reforms, Working Paper.

This paper offers a framework to establish a micro–based evaluation of a joint reform in personal income taxes, and/or social security contributions and indirect taxes. One often lacks an encompassing model for both the labour supply decisions in real world tax and benefit contexts and the allocation of disposable income to commodities. In this paper we elicit the assumptions which allow us to combine different submodels, such that an assessment of a joint reform becomes possible in a consistent conceptual framework. We characterise households’ labour supply decisions by a random utility random opportunity (RURO) model of job choice. We apply this framework to a Belgian tax reform which shifts the burden away from labour taxes to indirect taxation. We find substantial empirical evidence that, both from a distributional and from a budgetary perspective, it is important to account for the impact of indirect taxes on the labour supply decision of households when assessing this kind of joint tax reform. The cost recovery effects of the tax shift are negative. This is, among other things, explained by a more encompassing income effect in our job choice model, than is found in the more classic discrete choice model of labour supply.