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Wage Inequality and Optimal Tax

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  • Yena Park

    (University of Rochester)

Abstract

How should redistributive governments change tax schedule in response to increase in wage inequality? This paper investigate the impact of widening dispersion in wage inequality on optimal tax policy, especially focusing on the adjustment of the wage compression channel (Stiglitz (1982)). The response of tax policy depends on the source of the increasing wage inequality. If the wage inequality is mostly explained by the residual inequality, which is generated by the increasing dispersion in unobserved ability, the return to unobserved skill can be decreasing. Thus, increasing wage inequality caused by widening dispersion in unobserved ability makes wage compression channel when setting optimal tax, which will make the tax schedule relatively less regressive.

Suggested Citation

  • Yena Park, 2019. "Wage Inequality and Optimal Tax," 2019 Meeting Papers 1497, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:1497
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