Working Paper: CEPR ID: DP10071
Authors: Nezih Guner; Martin Lopez-Daneri; Gustavo Ventura
Abstract: We evaluate the effectiveness of a more progressive tax scheme in raising government revenues. We develop a life-cycle economy with heterogeneity and endogenous labor supply. Households face a progressive income tax schedule, mimicking the Federal Income tax, and flat-rate taxes that capture payroll, state and local taxes and the corporate income tax. We parameterize this model to reproduce aggregate and cross-sectional observations for the U.S. economy, including the shares of labor income for top earners. We find that a tilt of the Federal income tax schedule towards high earners leads to small increases in revenues which are maximized at an effective marginal tax rate of about 36.9% for the richest 5% of households -- in contrast to a 21.7% marginal rate in the benchmark economy. Maximized revenue from Federal income taxes is only 8.4% higher than it is in the benchmark economy, while revenues from all sources increase only by about 1.6%. The room for higher revenues from more progressive taxes is even lower when average taxes are higher to start with. We conclude that these policy recommendations are misguided if the aim is to exclusively raise government revenue.
Keywords: labor supply; progressivity; taxation
JEL Codes: E6; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increasing the progressivity of the income tax schedule (H31) | Small increases in revenues (H29) |
| Higher average tax rates (H29) | Reduced potential for increased revenues from more progressive taxes (H29) |
| Tax progressivity (H29) | Government revenues (H29) |
| Curvature of the tax function (H21) | Labor supply (J22) |
| Curvature of the tax function (H21) | Output (Y10) |
| Labor supply (J22) | Government revenues (H29) |
| Output (Y10) | Government revenues (H29) |