Working Paper: NBER ID: w28006
Authors: Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
Abstract: We address this question in a heterogeneous-agent incomplete-markets model featuring exogenous idiosyncratic risk, endogenous skill investment, and flexible labor supply. The tax and transfer schedule is restricted to be log-linear in income, a good description of the US system. Rising inequality is modeled as a combination of skill-biased technical change and growth in residual wage dispersion. When facing shifts in the income distribution like those observed in the US, a utilitarian planner chooses higher progressivity in response to larger residual inequality but lower progressivity in response to widening skill price dispersion reflecting technical change. Overall, optimal progressivity is approximately unchanged between 1980 and 2016. We document that the progressivity of the actual US tax and transfer system has similarly changed little since 1980, in line with the model prescription.
Keywords: Income Inequality; Tax Progressivity; Heterogeneous-Agent Models; Optimal Taxation
JEL Codes: E24; H21; J24; J3; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rising residual wage dispersion (J31) | increase tax progressivity (H29) |
| widening skill price dispersion (D39) | decrease tax progressivity (H29) |
| skill-biased technical change (J24) | widening skill price dispersion (D39) |
| various sources of rising income inequality (D31) | optimal tax progressivity (H21) |
| actual US tax and transfer system's progressivity stability from 1980 to 2016 (H29) | optimal progressivity stability (H21) |