In the initial position, the marginal and average tax rates
are [m.sup.*] and [a.sup.*], and our approach is to use Equations (2) and (3) to see how effort and evasion change in response to discrete changes in the tax schedule.
To analyze the effect on the average tax rate
of government ownership of capital, I simulate both model economies over four generations or periods 1,000 times and take averages of the tax rates and capital stock that are produced by the simulations.
One line of argument is as follows: when the wage rate is determined in a firm-union set up, an increase in the marginal tax rate with the average tax rate
held constant tends to increase the opportunity cost of foregone employment, which unambiguously decreases the pre-tax wage rate.
If the baseline for evaluating tax changes is taken as a constant average tax rate
and a constant replacement rate for spending on social benefits, then the discretionary changes in taxation and expenditure would amount to 0.5 per cent of GNP in a full year.
Because the marginal tax rate determines work incentive and because the average tax rate
determines total tax revenue, percent of tax revenue/taxable income is chosen to represent the tax rate.
Example: Individual X, with an average tax rate
of 25% during working years, saves $100 annually under a fully deductible TDS plan, such as an IRA.
Using time series from the United Kingdom, Robson (1998) finds that higher average tax rates
have a positive effect on entrepreneurship.
(10) However, it is clear that the current system, in which married women typically face high average tax rates
on even small amounts of income, causes economic harm by discouraging women from working.
We construct an average tax rate
on capital income using the methodology of Jones (2002) and Mendoza, Razin, and Tesar (1994).
The estimates are based on average tax rates
and real adjusted gross income (AGI) data for all tax returns filed as reported in the IRS periodical publication Statistics of Income.
Figure 3 illustrates the average tax rates
(also as a percentage of net national output) by major type of tax.
Economists have long recognized that average tax rates
do not provide a good measure of the tax disincentives to investment.