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Optimal Taxation Over the Life Cycle

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  • Aspen Gorry

    (University of California, Santa Cruz)

  • Ezra Oberfield

    (Federal Reserve Bank of Chicago)

Abstract

We derive the optimal labor income tax schedule for a life cycle model with deterministic productivity variation and complete asset markets. An individual chooses whether and how much to work at each date. The government must finance a given expenditure and does not have access to lump sum taxation. We develop a solution method that uses the primal approach to solve for the optimal non-linear tax function. The average tax rate determines when an individual will work while the marginal tax rate determines how much she will work. Even in the absence of redistributive concerns, the optimal tax schedule has an increasing average tax rate at low levels of income to encourage labor market participation. The marginal tax rate at the top is strictly positive. Finally, the model is used to assess the effects of changing the current tax schedule to the optimal one. Under the preferred parameters, this delivers a welfare gain equivalent to 0.67 percent of lifetime consumption. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2012.05.002
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 15 (2012)
Issue (Month): 4 (October)
Pages: 551-572

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Handle: RePEc:red:issued:11-116

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Keywords: Optimal taxation; life cycle; extensive margin; Ramsey problem; non-linear taxation; primal approach;

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Citations

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Cited by:
  1. Philippe Choné & Guy Laroque, 2014. "Income tax and retirement schemes," Sciences Po Economics Discussion Papers 2014-06, Sciences Po Departement of Economics.
  2. Jean-Baptiste Michau, 2011. "Optimal Redistribution with Intensive and Extensive Labor Supply Margins: A Life-Cycle Perspective," Working Papers hal-00639121, HAL.
  3. Philippe Choné & Guy Laroque, 2014. "Income tax and retirement schemes," Sciences Po publications 2014-06, Sciences Po.
  4. Michau, Jean-Baptiste, 2014. "Optimal redistribution: A life-cycle perspective," Journal of Public Economics, Elsevier, vol. 111(C), pages 1-16.

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