Working Paper: NBER ID: w27622
Authors: Corina Boar; Virgiliu Midrigan
Abstract: What are the most efficient means of redistribution in an unequal economy? We answer this question by characterizing the optimal shape of non-linear income and wealth taxes in a dynamic general equilibrium model with uninsurable idiosyncratic risk. Our analysis reproduces the distribution of income and wealth in the United States and explicitly takes into account the long-lived transition dynamics after policy reforms. We find that a uniform flat tax on capital and labor income combined with a lump-sum transfer is nearly optimal. Though allowing for increasing marginal income and wealth taxes raises welfare, the incremental gains are small due to strong behavioral and general equilibrium effects. This result is robust to changing household preferences, the distribution of ability, the planner’s preference for redistribution, as well as to explicitly modeling private business ownership and the ensuing heterogeneity in rates of return.
Keywords: redistribution; income tax; wealth tax; welfare; inequality
JEL Codes: E2; E6; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| flat uniform tax on labor and capital income (H31) | welfare gains (D69) |
| nonlinear taxation (H29) | incremental gains in welfare (D69) |
| wealth taxes (H24) | redistribution (H23) |
| flat tax (H25) | consumption-equivalent welfare increases (D11) |
| nonlinear taxes (H29) | slight increase in welfare (D69) |