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International Tax and Public Finance

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01-08-2012

Should remittances be taxed or subsidized?

Author: John Douglas Wilson

Published in: International Tax and Public Finance | Issue 4/2012

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Abstract

This paper analyzes the optimal nonlinear schedule of taxes and subsidies on remittances from emigrants. The analysis identifies conditions under which emigrants remitting small amounts of income face positive average and marginal subsidies on their remittances, whereas emigrants remitting relatively large amounts of income face positive marginal taxes. In this way, the tax system improves the distribution of income by indirectly taxing the “brain drain,” while simultaneously encouraging remittances that tend to go to low-income residents.

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For a review, see Wilson (2009).

Bhagwati’s original proposal (Bhagwati 1972) was followed by two edited volumes (Bhagwati and Partington 1976; Bhagwati 1976) that investigated the economic and legal issues that it raised. Another edited volume (Bhagwati and Wilson 1989) looked at migration and tax policy more generally, including the problems that emigration creates for the home country’s tax policy when it is unable to tax emigrants. See Wilson (2007) for a recent review of the literature on the Bhagwati’s proposal.

See Rapoport and Docquier (2006) for a review of the literature on such processes.

More generally, Chami et al. (2008) review past studies on this issue and present their own empirical estimates, concluding that “… it is difficult to obtain a robust positive effect of workers’ remittances on economic growth … remittances may be reducing economic growth in many countries” (p. 64).

Chami et al. (2008, Chap. 6) use a stochastic general equilibrium model with a representative consumer to explore the related issue of how remittances affect the optimal taxes on labor and consumption. In contrast to the labor tax, the consumption tax indirectly taxes remittances, since the tax base is domestic production and remittances (which are exogenous in the model). The authors conclude that the consumption tax is superior to the labor tax, with the welfare difference growing as the remittance-to-income ratio increases. An important task for future research is to construct an optimal tax model where both remittances taxes and income and consumption taxes are jointly optimized.

See Wilson (2008) for a model with return migration.

Of course, the density function for remitters will converge to zero as n goes to infinity. The absence of a top income is now common in the optimal income tax literature because results that depend on a top income—most notably, the conclusion that the marginal tax on the top income is zero—have been found to have little relevance for the shape of the tax schedule at incomes not near the top.

The possibility of subsidizing remitters before they emigrate is later discussed.

We could generalize by assuming that the marginal benefit of s _n also increases with n, but this would lengthen the notation without providing additional insights.

A similar assumption has been employed by Diamond (1998) and others to obtain additional insights about the shape of the optimal tax schedule for income taxation.

For simplicity, the government is assumed to treat all elements of remittance costs identically in the measurement of welfare, regardless of whether they are emigration costs or the out-of-pocket costs incurred in making remittances.

The interpretation here is that remitter income n is highly correlated with recipient income. In particular, we assume that remitter income is not largely driven by luck. For example, low-skilled migrants coming from low-income families do not normally end up as wealthy entrepreneurs. It would be useful, but much more complicated, to extend the model to recognize that remitters of a given type n differ in the characteristics of their family members in the home country.

For Latin American countries, Acosta et al. (2008b) present evidence of the poverty-reducing benefits of remittances, but they also find that the accompanying emigration significantly reduces these benefits, even reversing them in several countries. [In the model presented here, the opportunity costs of emigration are accounted for by the term v ^∗(n) in objective function (2).] Looking at estimated Gini coefficients, they also find that, except for Nicaragua and Peru, when nonremittances household income and total income are compared, nonremittances income is found to be more unequal. But the difference in estimated Gini coefficients is found to be small.

Gordon and Li (2009) present a theory of optimal taxation for developing economies that recognizes that transactions undertaken through the financial system can be taxed, due to the government’s access to transaction records, whereas transactions occurring through the informal sector cannot be taxed. It would be useful to extend the current model to include important elements of their theory. Along with undertaking policies that encourage the use of the financial system for making remittances, upper limits would be placed on the size of remittance taxes, to reduce incentives to send remittances through informal channels.

Freund and Spatafora (2005) review evidence suggesting costs in the informal sector are about 2–5 % of the amount sent, while costs in the formal sector are on average about 10–20 %.

Acosta, P., Fajnzylber, P., & López, J. H. (2008a). How important are remittances in Latin American. In P. Fajnzylber & J. H. López (Eds.), Remittances and development: lessons from Latin American. Washington: The International Bank for Reconstruction and Development/The World Bank (Chapter 2).

Acosta, P., Calderón, C., Fajnzylber, P., & López, J. H. (2008b). Do remittances lower poverty levels in Latin America. In P. Fajnzylber & J. H. López (Eds.), Remittances and development: lessons from Latin American. Washington: The International Bank for Reconstruction and Development/The World Bank (Chapter 4).

Ang, A. P. (2007). Workers’ remittances and economic growth in the Philippines. DEGIT Conference Papers c012_029.

Bhagwati, J. N. (1972). The United States in the Nixon era: the end of innocence. Daedalus, 101, 25–47.

Bhagwati, J. N. (Ed.) (1976). The brain drain and taxation, Vol. 2: Theory and empirical analysis. Amsterdam: North-Holland.

Bhagwati, J. N., & Partington, M., (Eds.) (1976). Taxing the brain drain, Vol. 1: A proposal. Amsterdam: North-Holland.

Bhagwati, J. N., & Wilson, J. D. (Eds.) (1989). Income taxation and international mobility. Cambridge: MIT Press.

Chami, R., Barajas, A., Cosimano, T., Fullenkamp, C., Gapen, M., & Montiel, P. (2008). Macroeconomic consequences of remittances. International Monetary Fund, Occasional Paper 259.

Diamond, P. A. (1998). Optimal income taxation: an example with a u-shaped pattern of optimal marginal tax rates. American Economic Review, 88, 83–95.

Freund, C., & Spatafora, N. (2005). Remittances: transaction costs, determinants, and informal flows. World Bank Policy Research Working Paper 3704.

Gordon, R., & Li, W. (2009). Tax structure in developing countries: many puzzles and a possible explanation. Journal of Public Economics, 93, 855–866. CrossRef

Keen, M., & Ligthart, J. (2006). Information sharing and international taxation: a primer. International Tax and Public Finance, 13, 81–110. CrossRef

Mirrlees, J. A. (1982). Migration and optimal income taxes. Journal of Public Economic, 18, 319–341. CrossRef

Mohapatra, S., Ratha, D., & Silwa, A. (2010). Outlook for remittance flows 2011-12. Migration and Development Brief 13, Migration and Remittances Unit, World Bank.

Rapoport, H., & Docquier, F. (2006). The economics of migrants’ remittances. In S.-C. Kolm & J. Mercier Ytheir (Eds.), Handbook of the economics of giving, altruism and reciprocity (Vol. 2). Amsterdam: North-Holland. Chap. 17.

Saez, E. (2001). Using elasticities to derive optimal income tax rates. Review of Economic Studies, 68, 205–229. CrossRef

Stark, O., & Wang, Y. (2002). Inducing human capital formation: migration as a substitute for subsidies. Journal of Public Economics, 86, 29–46. CrossRef

Taylor, J. E. (1992). Remittances and inequality reconsidered: direct, indirect and intertemporal effects. Journal of Policy Modeling, 14, 187–208. CrossRef

Taylor, J. E., & Wyatt, T. J. (1996). The shadow value of migrant remittances, income and inequality in a household-farm economy. Journal of Development Studies, 32, 899–912. CrossRef

Wilson, J. D. (2007). Taxing the brain drain: a reassessment of the Bhagwati proposal. In E. Dinopoulos, P. Krishna, A. Panagariya, & K.-Y. Wong (Eds.), Trade, globalization and poverty. London: Routledge.

Wilson, J. D. (2008). A voluntary brain-drain tax. Journal of Public Economics, 92, 2385–2391. CrossRef

Wilson, J. D. (2009). Income taxation and skilled migration: the analytical issues. In J. N. Bhagwati & G. H. Hanson (Eds.), Skilled immigration today: prospects, problems, and policies. New York: Oxford University Press.

Title: Should remittances be taxed or subsidized?
Author: John Douglas Wilson
Publication date: 01-08-2012
Publisher: Springer US
Published in: International Tax and Public Finance / Issue 4/2012
Print ISSN: 0927-5940
Electronic ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-012-9237-9

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