The presentation discusses Digitalization and Taxation in various matters, i.e. 1) how it can help expanding tax base, 2) how it can help striking optimality between efficiency vs equity, and 3) also others issues regarding such tax policy as optimal tax policy and negative income tax. It will discuss how we can use reinforcement learning ABMs to justify the policy.

1. Digitalization and Taxation
Kan Yuenyong
February 18, 2021
GSPA
NIDA DA8410: Fiscal and Monetary Policy Analysis
Keywords: Digitalization, Taxation, Digital Governance, Welfare Economics, Sovereignty Credit Rating, Efficiency, Equity, Tax Enforcement, Reinforcement Learning ABMs,
Optimal Tax Theory, Negative Income Tax,

2. Based on
Jacobs, B. (2017). Digitalization
and Taxation (chapter 2), in
Gupta, S. et al. (editor), Digital
Revolutions in Public Finance.
International Monetary Fund.

3. Ideal government (Econ theory, not Weberian)
• No cost on assessment of economic outcome and characteristics of taxpayer
• No distortion on income redistribution & raising revenue for the gov
• Perfectly managing income redistribution based on each taxpayer’s: earning ability,
needs, initial endowments, inheritances, luck, and so on
• Perfect information on each taxpayer’s earn-save-consume, thus, no tax avoidance and
evasion.
• Plus perfect market condition (no externalities, no monopoly, complete contracts,
symmetric information, complete markets, and zero transaction costs), 2nd fundamental
theorem of welfare economic holds -> separation between goals of efficiency vs equity
-> redistribution is possible via individualized lump-sum taxed & transfer

4. The second welfare theorem
We have two Pareto efficient allocations E and Eʹ. If it is felt that equilibrium Eʹ is somehow better in terms of being more fair or just than equilibrium E, then a lump-sum transfer of good X
from individual A to B and simultaneously a transfer of good Y from B to A, changing the endowment from W to Wʹ, can be made. The price system can then be allowed to generate a
Pareto efficient outcome Eʹ, given the new endowment Wʹ. Thus, as per the second welfare theorem— given all agents have convex preferences, after an appropriate assignment of
endowments through redistribution, a society may achieve any Pareto efficient resource allocation as competitive equilibrium, that is, through market mechanism.
(Note: the 1st welfare theorem is the Pareto optimality is possible)
http://egyankosh.ac.in/bitstream/123456789/70577/1/Unit-8.pdf , https://en.wikipedia.org/wiki/Fundamental_theorems_of_welfare_economics
(i.e.
Meat)
(i.e. Fruit)

5. Government in reality
• Government is not able to verify all economic outcomes of individuals or households
• Taxpayers may misrepresent their incomes, consumption, wealth, or bequests to avoid or even
evade paying taxes
• Information constraints determine a government’s tax enforcement capacity
• Governments use costly verification of economic outcomes (tax audits) and penalties for
noncompliance, to alleviate information problems in verifying economic outcomes
• The taxpayer’s willingness to tolerate risk, the size of penalties if caught evading, and the tax
enforcement technology determine the extent of tax avoidance
• Governments cannot verify important characteristics (such as earning abilities) and economic
behaviors of individuals and firms (such as work effort). Government must rely on taxing verifiable
economic outcomes such as income (output), consumption, savings, and bequests

6. • Information constraints imply that government inevitably distorts
incentives to earn income, to consume, to save, and to leave a bequest.
• Information constraints thus determine the opportunities for tax avoidance
and evasion
• Such constraints are, therefore, the fundamental reason for the ultimate
trade-off between equity and efficiency
• Also, another constraint is about the gov’s fiscal capability, which is
normally contained by “The Big Three” credit rating agencies
Trade-off between equity vs efficiency

7. https://www.bangkokpost.com/opinion/opinion/409824/
while-our-economists-learn-our-politicians-fail-us
https://asia.nikkei.com/Spotlight/Asia-Insight/Asia-faces-
financial-health-check-after-going-big-on-stimulus
Who control(s) national fiscal budget?
Note: TRIS Rating’s path of development as a key pillar of the Thai debt capital market was marked with another crucial milestone in June
2016 when S&P Global Ratings, the world’s leading provider of credit risk research services, acquired a 49% equity stake in TRIS Rating
from its parent company, TRIS. The transaction signified the deepening of collaborations between TRIS Rating and S&P Global Ratings that
started in 1993. https://www.trisrating.com/about-us/company/

8. The logistic estimated coefficients for these variables have the expected sign. Changes in real exchange rate, gross domestic savings,
government revenue and corruption index have a significant positive impact on ratings. Note that the coefficient of the corruption index
is positive since the highest note (10) is attributed to uncorrupted countries. Moreover, this index is also a good proxy for the quality of
governance. These findings corroborate the idea that developed and more competitive countries have higher ratings, in general, than
developing countries. Negative effect on ratings is produced by inflation (consumer prices), trade dependency and external debt. This
effect reflects the fact that countries with lower levels of foreign debt and low inflation are less likely to default, and get a better rating.
The results underpin the strong influence of the default history of sovereign borrowers over rating agencies’ decisions. The coefficient of
the dummy variable is high and statistically different from zero. This means that countries that have defaulted once on their official debt
are rated, on average, 1.4 notches below countries with good track records.
https://www.tandfonline.com/doi/abs/10.1080/13518470500377406?scroll=top&needAccess=true&journalCode=rejf20
Which factors determine sovereign credit rating?

9. • According to an analysis by Deutsche Welle, "their special status has been cemented by law — at first only in the United
States, but then in Europe as well.” From the mid-1990s until early 2003, the Big Three were the only "Nationally Recognized
Statistical Rating Organizations (NRSROs)" in the United States — a designation meaning they were used by the US
government in several regulatory areas. (Four other NRSROs merged with Fitch in the 1990s.) As of December 2016, nine
organizations were designated as NRSROs, including the Big Three.
• The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of
the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In
some cases, they were obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have
happened without the rating agencies.
• one or more of the Big Three relegated Greece, Portugal and Ireland to "junk" status – a move that many EU officials say has
accelerated a burgeoning European sovereign-debt crisis. In January 2012, amid continued eurozone instability, S&P
downgraded nine eurozone countries, stripping France and Austria of their triple-A ratings.
• A common criticism of the Big Three, and one that was highly linked to bank failure in the 2008 recession, is the dominance
the agencies had on the market. As the three agencies held 95% of the market share, there was very little room for
competition. Many feel this was a crucial contributor to the toxic debt-instrument environment that led to the financial
downturn. In a preliminary exchange of views in the European Parliament Committee on Economic and Monetary Affairs, held
in late 2011, it was advocated that more competition should exist amongst rating agencies. The belief was that this would
diminish conflicts of interest and create more transparent criteria for rating sovereign debt.
• https://en.wikipedia.org/wiki/Big_Three_(credit_rating_agencies)#2007%E2%80%932010_financial_crisis
The political economy of “The Big Three”

10. Fitch rating owned 80% by Hearst
Communications and 20% by FIMALAC

11. William Randolph Hearst was the Rupert Murdoch of his day. “He is,”
President Teddy Roosevelt once wrote, “the most potent single
influence for evil we have in our life.” Hearst inherited his father’s
newspaper business and kept going: At his peak, he owned 28 major
newspapers and 18 magazines, not to mention radio stations and
movie studios. At 23, two years after getting kicked out of Harvard,
he took control of the San Francisco Examiner. He acquired the New
York Morning Journal in 1895 and turned it into a bastion of
sensational celebrity news and yellow journalism. He married a
chorus girl named Millicent. Although he lost in two bids to become
Mayor of New York City and another to become Governor of the
state, in 1902 he did win election to Congress. Fireworks at a
celebration in Madison Square Garden reportedly killed dozens. His
towering personality was portrayed in Orson Welles’ Citizen Kane.
Hearst offered RKO Pictures $800,000 destroy all prints and burn the
negatives of the film. When he died in 1951, he gave his sons five of
the 13 seats on the board of trustees overseeing the Hearst
Corporation. https://observer.com/2006/12/the-hearst-family/
Now in the second volume of this sweeping biography, Ben Procter
gives readers a vivid portrait of the final 40 years of Hearst's life.
Drawing on previously unavailable letters and manuscripts, and
quoting generously from Hearst's own editorials, Procter covers all
aspects of Hearst's career: his journalistic innovations, his
impassioned patriotism, his fierce belief in "Government by
Newspaper," his frustrated political aspirations, profligate spending
and voracious art collecting, the building of his castle at San Simeon,
and his tumultuous Hollywood years.
“Government by Newspaper”

12. High income countries announced larger fiscal policies than lower-income countries.
Sovereign credit rating is the most important determinant of its fiscal spending during the pandemic.
Benmelech & Tzur-Ilan. (2020). “The Determinants of Fiscal and Monetary Policies During the Covid-19 Crisis”. NBER. https://www.nber.org/papers/w27461
Constraints on fiscal policy

13. Another risk assessment index
Dario Caldara and Matteo Iacoviello construct a monthly index of Geopolitical Risk (GPR Index) counting the occurrence of words related to
geopolitical tensions in leading international newspapers. The GPR index spikes around the Gulf War, after 9/11, during the 2003 Iraq
invasion, during the 2014 Russia-Ukraine crisis, and after the Paris terrorist attacks.
https://www.matteoiacoviello.com/gpr.htm#charts

14. Three objectives of tax policy
• Expanding the tax base
• Easing efficiency-equity trade-off
• Poverty alleviation
• (Plus addressing a global problem on digital platforms in the sharing and gig
economy https://www.oecd.org/tax/exchange-of-tax-information/oecd-
releases-global-tax-reporting-framework-for-digital-platforms-in-the-
sharing-and-gig-economy.htm)
• To criticize the real world government or to moving closer to the “ideal
government”?

15. How digitalization can help?
• Enable to link existing information in various parts of the tax system to better detect evasion or
avoidance (tax enforcement technology) -> (1) raise the same revenue with lower taxes (more
efficiency) or (2) to raise more tax revenue with the same taxes.
• Enable to implement sophisticated tax systems (to alleviate the equity-efficiency trade-off), i.e.
tax liabilities can be conditioned not only on current yearly (labor) income, but also on income
earned in different periods, income earned by spouses, asset holdings, etc. -> better target
income redistribution -> the same income redistribution can be achieved with lower tax rates,
or the same tax rates can achieve more income redistribution
• Optimal tax design: (1) reducing tax avoidance and evasion and (2) the optimal design of taxes
on labor, capital, and consumption.
• Note: Important economic behaviors remain the private information of tax-payers and therefore
unobservable to tax authorities (such as work effort). This remains so even in a fully digitized
world

16. Five proposals to improve the tax enforcement
technology of the government
• Digitalization may provide the government with greater information on individual consumption, such
as due to increased use of digital payment methods and the phasing out of cash payments.
• Digitalization can help to generate information on and improve existing links between wealth (traded
and non-traded assets, homeownership, pensions) and capital incomes (interest, dividends, capital
gains, property income, pension accrual).
• International information exchange can be made automatic and can be improved by creating
international registers for asset ownership and capital incomes.
• Digitalization allows financial institutions to act better as third-party reporters on capital incomes
and wealth for the government.
• Digitalization makes it possible for consumers to act as third-party reporters for the VAT or sales
tax, for example, by using electronic payment information (such as debit and credit card payments).

17. Eight proposals to improve the equity-efficiency
trade-off by designing more efficient tax systems
• International registers of asset ownership and shareholders allow for taxation of capital income on residence rather than on
source basis. The corporate income tax could be used as a withholding tax on dividend income or abolished altogether.
• By combining information on all assets and capital incomes, a dual-income-tax system could be introduced, under which
all capital incomes and wealth are linked and taxed under a single tax schedule: a synthetic capital income tax.
• In developing economies, biometric identification and electronic transaction systems could allow progressive consumption
taxes, reducing the need for low VAT rates on necessities for income redistribution.
• Nonlinear consumption taxes could be levied on goods that are perishable, non-storable, and non-transportable.
• Vickrey’s (1947) proposal for an average tax on cumulative income could be implemented. Alternatively, marginal tax rates
could be made dependent on entire earnings histories.
• Tax schedules could jointly tax labor and capital income or wealth.
• Tax schedules could jointly tax individual and household income.
• Separate tax schedules could be introduced based on individual or household characteristics, such as gender, age,
disability, health, or children (“tagging”; Akerlof 1978).

18. • In welfare economics, even if we can reach Pareto optimality, but there is no things as “perfect equality”, we need to
reach the possible equality (sound proportional wealth distribution among “economic strata”) at Pareto optimality.
• But how?
• Apart of efficiency & equity tradeoff, it is needed to address poverty alleviation.
• Economists agree there are problems with this system (welfare system), such as in-kind benefits taking away people’s
autonomy to buy what they think they need most and being generally less effective at lifting people out of poverty. But
perhaps one of the biggest flaws in the system is what happens when welfare recipients start to earn more money.
“The irony of our welfare system is that poor people pay very high taxes — for each dollar of earnings they lose
benefits,” Angrist said. That is to say, by working, people on welfare may actually find themselves worse off —
particularly if they earn enough to lose benefits but not enough to pay for those things themselves.
• A negative income tax, as Friedman saw it, would therefore solve two main problems: It would give people cash as
opposed to in-kind benefits and have a much lower tax rate. While people would still lose benefits the more they
made, with a negative income tax, they would always come out ahead with a higher income. https://mitsloan.mit.edu/
ideas-made-to-matter/negative-income-tax-explained
• Is present policy of rice price guarantee scheme a kind of “negative income tax”?
Striking the optimality between efficiency vs equity

19. (An example on how to apply reinforcement learning ABMs on policy analysis)
Our experiments show the AI Economist can improve the trade-off between equality and productivity by 16%, compared to a prominent tax
framework proposed by Emmanuel Saez, with even larger gains over an adaptation of the US Federal income tax and the free market.
https://blog.einstein.ai/the-ai-economist/
The AI Economist: Improving Equality and
Productivity with AI-Driven Tax Policies

20. https://www.youtube.com/watch?v=4iQUcGyQhdA

21. Limitations: (1) Need to include different rebate program (including either negative income tax or earned income tax credit (EITC), (2) They
do not yet model human-behavioral factors and interactions between people, including social considerations, and they consider a
relatively small economy.
See paper at: https://arxiv.org/abs/2004.13332 and code at: https://github.com/salesforce/ai-economist?utm_source=catalyzex.com ,
https://colab.research.google.com/github/salesforce/ai-economist/blob/master/tutorials/
economic_simulation_basic.ipynb#scrollTo=t2eR5M-r7Lgb

22. Output from Colab’s notebook

23. END | Q&A?
GSPA
NIDA DA8410: Fiscal and Monetary Policy Analysis
Q&A?
END