Working Paper: CEPR ID: DP16863
Authors: Christian Hellwig; Nicolas Werquin
Abstract: We study optimal tax design based on the idea that policy-makers face trade-offs between multiple margins of redistribution. Within a Mirrleesian economy with earnings, consumption and retirement savings, we derive a novel formula for optimal non-linear income and savings distortions based on redistributional arbitrage. We establish a sufficient statistics representation of the labor income and capital tax rates on top income earners, which relies on the comparison between the Pareto tails of income and consumption. Because consumption is more evenly distributed than income, it is optimal to shift a substantial fraction of the top earners' tax burden from income to savings. Our results extend to economies with one-dimensional heterogeneity and general preferences over an arbitrary set of commodities.
Keywords: optimal tax design; redistribution; income tax; savings tax; Pareto distribution
JEL Codes: H21; D31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal tax policy should shift tax burden from income to savings (H21) | optimal labor income tax rate is influenced by Pareto tails of income and consumption (H31) |
| marginal resource gains from redistributing consumption and savings must be equalized (D63) | direct relationship between tax burden and distributional characteristics of income and consumption (H22) |
| reduction in the top income tax rate from 80% to between 50% and 60% when accounting for consumption measures (E25) | optimal savings tax could range from 40% to 50% depending on various elasticities and distributional parameters (H21) |