Working Paper: NBER ID: w20780
Authors: Mikhail Golosov; Aleh Tsyvinski; Nicolas Werquin
Abstract: We develop a general method to study the effects of non-linear taxation in dynamic settings using variational arguments. We first derive general theoretical formulas that characterize the welfare effects of local tax reforms and, in particular, the optimal tax system, potentially restricted within certain classes (e.g., age-independent, linear, separable). These formulas are expressed in terms of intuitive parameters, such as the labor and capital income elasticities and the hazard rates of the income distributions. Second, we apply these formulas to various specific settings. In particular, we decompose the gains arising from each element of tax reform, starting from a simple baseline system, as the available tax instruments becomes more sophisticated. We further show that the design of tax systems obeys a common general principle, namely that more sophisticated tax instruments (e.g., age-dependent, non-linear, non-separable) allow the government to fine-tune the tax rates by targeting higher distortions to the segments of the population whose behavior responds relatively little to those taxes.
Keywords: nonlinear taxation; welfare effects; tax reforms; optimal tax systems
JEL Codes: H21; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonlinear taxation (H29) | welfare improvements (I38) |
| sophisticated tax instruments (F38) | higher welfare (I31) |
| sophisticated tax instruments (F38) | better targeting of distortions (F12) |
| tax sophistication (H26) | welfare gains (D69) |