English, Article, Journal or magazine article edition: On the Optimal Progressivity of the Income Tax Code Juan Carlos Conesa; Dirk Krueger

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Physical Description
  • preprint
Language
  • English

Edition details

Title
  • On the Optimal Progressivity of the Income Tax Code
Author
  • Juan Carlos Conesa
  • Dirk Krueger
Physical Description
  • preprint
Notes
  • 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 o¤ against the e¢ciency loss arising from distorting endogenous labor supply and capital accumulation decisions. A determination of the optimal progressivity of the income tax code therefore calls for a quantitative exploration. Using a utilitarian steady state social welfare criterion we find that the optimal US income tax is well approximated by a flat tax rate of 19.5% and a fixed deduction of about $3,700: The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 0.4% 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, however, that a majority of the population currently alive would suffer welfare losses, calling into question the political feasibility of such fundamental income tax reform.
  • RePEc:cae:caerpp:4
  • RePEc:nbr:nberwo:11044
  • 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. Using 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.
  • Progressive Taxation, Optimal Taxation, Flat Taxes, Social Insurance, Transition
  • RePEc:cfs:cfswop:wp200510
Language
  • English
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