Working Paper: NBER ID: w11044
Authors: Juan Carlos Conesa; Dirk Krueger
Abstract: This paper computes the optimal progressivity of the income tax code in a dynamic general equilibrium model with household heterogeneity in which uninsurable labor productivity risk gives rise to a nontrivial income and wealth distribution. A progressive tax system serves as a partial substitute for missing insurance markets and enhances an equal distribution of economic welfare. These beneficial effects of a progressive tax system have to be traded off against the efficiency loss arising from distorting endogenous labor supply and capital accumulation decisions. \nUsing a utilitarian steady state social welfare criterion we find that the optimal US income tax is well approximated by a flat tax rate of 17.2% and a fixed deduction of about $9,400. The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 1.7% higher consumption in each state of the world. An explicit computation of the transition path induced by a reform of the current towards the optimal tax system indicates that a majority of the population currently alive (roughly 62%) would experience welfare gains, suggesting that such fundamental income tax reform is not only desirable, but may also be politically feasible.
Keywords: No keywords provided
JEL Codes: E62; H21; H24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| progressive tax system (H29) | economic welfare (D69) |
| progressive tax system serves as a partial substitute (H29) | missing insurance markets (G52) |
| tax reform (H20) | consumption (E21) |
| tax structure (H20) | individual welfare outcomes (I31) |
| progressive taxes (H29) | equity (D63) |
| progressive taxes (H29) | economic incentives (M52) |