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Optimal taxation and the skill premium

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  • Angelopoulos, Konstantinos
  • Malley, James
  • Philippopoulos, Apostolis

Abstract

The stylized facts suggest a negative relationship between tax progressivity and the skill premium from the early 1960s until the early 1990s, and a positive one thereafter. They also generally imply rising tax progressivity, except for the 1980s. In this paper, we ask whether optimal tax policy is consistent with these observations, taking into account the demographic and technological factors that have also affected the skill premium. To this end, we construct a dynamic general equilibrium model in which the skill premium and the progressivity of the tax system are endogenously determined, with the latter being optimally chosen by a benevolent government. We find that optimal policy delivers both a progressive tax system and model predictions which are generally consistent, except for the 1980s, with the stylized facts relating to the skill premium and progressivity. To capture the patterns in the data over the 1980s requires that we adopt a government policy which is biased towards the interests of skilled agents. Thus, in addition to demographic and technological factors, changes in the preferences of policy-makers appear to be a potentially important factor in determining the evolution of the observed skill premium.

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Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2012-03.

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Date of creation: 2012
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Handle: RePEc:edn:sirdps:306

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Keywords: skill premium; optimal tax policy; government preferences;

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  1. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers 2854, C.E.P.R. Discussion Papers.
  2. N. Gregory Mankiw & Matthew C. Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," Harvard Business School Working Papers 09-140, Harvard Business School.
  3. Conesa, Juan Carlos & Kitao, Sagiri & Krüger, Dirk, 2006. "Taxing Capital? Not a Bad Idea After All!," CEPR Discussion Papers 5929, C.E.P.R. Discussion Papers.
  4. Guido Cozzi & Giammario Impullitti, 2008. "Government spending composition, technical change and wage inequality," Working Papers 2009_02, Business School - Economics, University of Glasgow.
  5. Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 1995. "Supply side interventions and redistribution," Economics Working Papers 115, Department of Economics and Business, Universitat Pompeu Fabra.
  6. Oded Galor & Joseph Zeira, 2013. "Income Distribution and Macroeconomics," Working Papers 2013-12, Brown University, Department of Economics.
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