Modelling marginal tax rates in GreenREFORM

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06-02-2022
GreenREFORM

This note propose a general methodology for incorporating exogenous marginal tax rates in input demand functions of firms, while still respecting national accounts statistics on total production costs, tax payments etc. of the firms in any given sector.

Abstract

In this note, we propose a general methodology for incorporating exogenous marginal tax rates in input demand functions of firms, while still respecting national accounts statistics on total production costs, tax payments etc. of the firms in any given sector.

GreenREFORM is calibrated against very detailed input-output tables and various sattelite accounts from Statistics Denmark from a specific year (the data year), at present 2018. These statistics are build on strict accounting principles, which the model must also respect. Case in point, the value of production in a given sector is equal to total production costs including payments of a range of product specific taxes and net profits. In constructing the model, we typically connect the payment of these product specific taxes to the value of inputs in production from the most relevant sector, and calibrate an effective tax rate as the ratio between the tax payment and the value of those inputs. Say, if the payments of chocolate-tax (it is a real tax in Denmark) is 100 EUR, and the value of input from the food and beverage industry is 10,000 EUR, the effective chocolate tax rate would på 1 percent ad valorem.

Now, product specific taxes are not ad valorem but unit taxes. Since the chocolate tax is not important for the purpose of the GreenREFORM model, and since we therefore do not make account of the sales and purchases of chocolate (or other foods and beverages) in physical units, any discrepancies between the effective tax and actual tax rates (DDK per gram) will be obscured. The opposite is the case for energy and pollutants, which are obviously important for the purpose of GreenREFORM, and which we thus make account for in great detail and in physical units of energy content (joule) and mass (gram) respectively.

The effective tax rate based on national accounts are in practice never perfectly alligned with the objective marginal tax rates as per legislation. It may be due to discrepancies between data sources, lack of reliable data and subsequent errors of distribution of tax revenues, it may be because firms are not facing uniform tax rates, or that they are eligible to bottom deductions. The later is the case for some energy intensive industries with regard to the danish energy tax (energiafgift for virksomheder på proceslisten). The distribution of free allowances in the EU ETS system is another example.