This appendix discusses the choice of parameters for the baseline simulations. In setting the tax parameters, I draw on the fairly detailed discussion of recent reforms in the Polish income tax system in Gorecki and Wisniewski (1992). At the start of 1992, the Polish authorities introduced a new personal income tax system according to which income is taxed in three bands at the rates 20, 30 and 40 percent.18/ The bands are wide, being almost three times the average wage so it might seem reasonable to take the 20 percent rate as the baseline case. The bands are imperfectly indexed so the current flatness of the income tax structure is likely to change in the future. Also, labor income is taxed quite substantially through the excess wage tax levied on firms. While the authorities regard this tax as temporary, it may well be around for quite a long time and the total revenue it raises is very substantial. Hence, I adopt a baseline wage tax level of 25 percent and a baseline savings tax rate of 22 percent. Social security taxes are paid directly by firms through a 45 percent levy on the pre-tax enterprise payroll translating into a proportional tax rate of 31 percent.19/ On consumption goods taxes, the Polish authorities intend to replace the current system of turnover taxes with a Western-European-style Value Added Tax. This tax is likely to be introduced in mid-1993, although the implementation date has slipped back several times. This tax would have a reasonably wide coverage of different goods but the effective rate for consumption goods as a whole is unlikely to exceed 8 percent. Lastly, I assume a zero inheritance tax rate.
Utility function parameters for Poland are a matter of educated guesswork. There are almost no significant empirical studies and what past studies do exist used data from before a very substantial regime change involving a relaxation in quantity constraints on consumption, savings and labor supply behavior. The best approach is, therefore, to use reasonable values, suggested by the literature on other economies. I set the elasticity of intertemporal substitution, ρ, at 0.8. There is some controversy on reasonable values for this parameter in the US where a well-known study by Boskin found high substitution elasticity while other work, e.g. Carlino (1982), suggests lower values. The figure here is fairly high but still lower than Boskin’s estimate. I choose a subjective discount rate, δ, of 4 percent. The important figure is in fact the difference between δ and the after tax real interest rate. Since, I set the pre-tax interest rate at 5 percent, choosing 4 percent for & implies a gradually declining path for full consumption (given the fact that marginal utility is decreasing in consumption). I set the consumption-leisure elasticity of substitution also at 0.8. This figure implies a very small elasticity of labor supply, in line with estimates in other countries. It is hard to judge what a sensible value would be for the bequest substitution elasticity so, for simplicity, I set it at 0.8, the same as the elasticity of intertemporal substitution. The last utility parameters, the consumption-leisure parameter, α0, and the bequest-full-consumption parameter α1, largely determine what the household’s expenditure shares devoted to leisure and bequests. αo especially is fairly arbitrary since we normalize leisure endowment to unity and have little idea what proportion of leisure is actually consumed. It is reasonable to expect Polish households to attribute relatively low priority to bequests given expectations of rising living standards. In sum, it seems reasonable to set αo and α1 in the baseline to 0.2 and 0.1.
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I thank Ehtisham Ahmad, Michael Deppler, Liam Ebrill, Stanislas Gomulka, Cheng Hoon Lim and Christian Mulder for helpful conversations. I acknowledge a special debt to Thierry Pujol with whom an earlier paper using this model was written. The work presented in the present paper was begun while I was a visiting scholar in the European I Department of the International Monetary Fund. The views expressed are my own and do not necessarily reflect those of the Fund. Correspondence should be addressed to William Perraudin, Department of Applied Economics, Austin Robinson Building, Sidgwick Avenue, Cambridge, CB3 9DE, United Kingdom.
For comparison, the cost of unemployment benefits has risen steeply but from a low base and represented just 1.2 percent of GDP in 1991.
The main state pension scheme is administered by the Social Insurance Institution or ZUS. Two other state pension schemes exist for priests and private sector farmers.
Figures for women are given in parentheses after the corresponding figure for men.
Parliament initially approved more generous percentages but backed away from these given the budgetary implications.
Prior to the October 1991 law reforming the pension system, the final wage applicable to benefit calculations was just a workers’ earnings in the last twelve months of his working life.
Note that, for a given worker, the averaging rules depend upon the year of retirement, not age. This complicates optimal retirement decisions somewhat.
The new law came into force on 1st January, 1992, replacing four payroll and income taxes with a single personal income tax. For a detailed description, see Gorecki and Wisniewski (1992).
The deterioration has exceeded that in other Central or Eastern European countries (see Boeri and Keese (1992), page 150). Unemployment rates in Czechoslovakia and Hungary, for example, were 7.75 percent and 8 percent at the end of 1991.
For example, in the UK women represent 23 percent of total unemployment.
The December 1989 law allowed anyone out of work to claim unemployment benefit. In July 1990, eligibility was tightened so that benefit can only be obtained if no job or training program is available and if the claimant has worked for 180 days in the past year.
In contrast, Hambor suggests that the same ratio in the United States will decline from 4.7 in 1990 to 3.3 in 2020.
Note that the simulations assume that households receive no bequests. Including bequests would probably not change matters since these would normally be received around the age of fifty.
This is the approach taken in the US social security benefit system.
Although effective tax payments are, of course, cut since the household receives extra pension benefits in reward for extra supply of labor.
Recall that goods prices are normalized to unity and that the consumption tax rate is assumed to be 8 percent.
The tax replaced the old payroll tax as well as the less important income equalization tax and various small taxes on individual crafts and small manufactures.
Of the 45 percent, 43 percent goes towards the social insurance expenditures of the ZUS, while 2 percent is used as a contribution towards the costs of unemployment benefits. This distinction makes no difference to the economic effects of these taxes.