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Optimal Tax Progressivity: An Analytical Framework

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  • Heathcote, Jonathan

    (Federal Reserve Bank of Minneapolis)

  • Storesletten, Kjetil

    (University of Oslo)

  • Violante, Giovanni L.

    (New York University)

Abstract

What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, and aggravates the externality associated with valued public expenditures. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preferences, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the externality linked to valued government purchases play quantitatively similar roles in limiting desired progressivity.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 496.

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Length: 76 pages
Date of creation: 31 Jan 2014
Date of revision:
Handle: RePEc:fip:fedmsr:496

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Keywords: Progressivity; Income distribution; Skill investment; Labor supply; Partial insurance; Valued government expenditures; Welfare;

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  1. Optimal Tax Progressivity: An Analytical Framework
    by Christian Zimmermann in NEP-DGE blog on 2014-02-28 17:27:21
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Cited by:
  1. Laurence Ales & Kurnaz Musab & Sleet Christopher, . "Task, Talent, and Taxes," GSIA Working Papers 2014-E16, Carnegie Mellon University, Tepper School of Business.
  2. Laurence Ales & Soo-Haeng Cho & Ersin Korpeoglu, . "Innovation Tournaments with Multiple Contributors," GSIA Working Papers 2014-E17, Carnegie Mellon University, Tepper School of Business.
  3. Guner, Nezih & Lopez-Daneri, Martin & Ventura, Gustavo, 2014. "Heterogeneity and Government Revenues: Higher Taxes at the Top?," IZA Discussion Papers 8335, Institute for the Study of Labor (IZA).

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