Working Paper: CEPR ID: DP15394
Authors: Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
Abstract: We address this question in a heterogeneous-agent incomplete-markets model featuring exogenous idiosyncratic risk, endogenous skill investment, and flexible labor supply. The tax and transfer schedule is restricted to be log-linear in income, a good description of the US system. Rising inequality is modeled as a combination of skill-biased technical change and growth in residual wage dispersion. When facing shifts in the income distribution like those observed in the US, a utilitarian planner chooses higher progressivity in response to larger residual inequality but lower progressivity in response to widening skill price dispersion reflecting technical change. Overall, optimal progressivity is approximately unchanged between 1980 and 2016. We document that the progressivity of the actual US tax and transfer system has similarly changed little since 1980, in line with the model prescription.
Keywords: optimal taxation; redistribution; tax progressivity; labor supply; inequality
JEL Codes: D30; E20; H20; I22; J22; J24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rising inequality (D31) | higher tax progressivity (H29) |
| larger residual inequality (D31) | higher tax progressivity (H29) |
| widening skill price dispersion (D39) | lower tax progressivity (H29) |
| skill-biased technical change (J24) | rising inequality (D31) |
| growth in residual wage dispersion (J39) | rising inequality (D31) |