Working Paper: CEPR ID: DP2446
Authors: Roland Benabou
Abstract: This paper studies the effects of progressive income taxes and education finance in a dynamic heterogeneous agent economy. Such redistributive policies entail distortions to labour supply and savings, but also serve as partial substitutes for missing credit and insurance markets. The resulting tradeoffs for growth and efficiency are explored, both theoretically and quantitatively, in a model that yields complete analytical solutions. Progressive education finance always leads to higher income growth than taxes and transfers, but at the cost of lower insurance. Overall efficiency is assessed using a new measure which properly reflects aggregate resources and idiosyncratic risks but, unlike a standard social welfare function, does not reward equality per se. Simulations using empirical parameter estimates show that the efficiency costs and benefits of redistribution are generally of the same order of magnitude, resulting in reasonable values for the optimal rates. Aggregate income and aggregate welfare provide only very crude lower and upper bounds around the true efficiency tradeoff
Keywords: income distribution; heterogeneous agents; inequality; growth; redistribution; taxation; education finance
JEL Codes: D31; D63; E62; I22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| progressive education finance (I22) | higher income growth (O49) |
| progressive education finance (I22) | lower consumption insurance (G52) |
| progressive education finance (I22) | taxes and transfers (H29) |
| average marginal tax-and-transfer rate of 21% (H29) | maximizes long-run income growth (O49) |
| 6% share of redistributive transfers in GDP (H23) | maximizes long-run income growth (O49) |
| efficiency maximization (D61) | raises average marginal tax-and-transfer rate to 48% (H29) |
| efficiency maximization (D61) | raises share of redistributive transfers in GDP to 14% (F62) |
| income-maximizing equalization rate for school expenditures of 62% (H52) | economic implications (F69) |
| efficient rate of 68% for school expenditures (H52) | economic implications (F69) |
| redistribution (H23) | efficiency costs and benefits (D61) |