Income Tax Distortions And Tax Arbitrage
We present a simple static labor supply model with endogenous asset choice. Then, we examine how tax
avoidance through asset trading affects the labor supply response and the excess burden of income tax. Furthermore, we
discuss the implications of the tax policy analysis and show that a failure to account for avoidance responses may lead to
errors when estimating how tax reform affects labor supply and the welfare cost of taxation. Because of tax avoidance
through tax arbitrage, the progressivity of a given tax system will be less than what the formal tax system implies.