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On the optimality of age-dependent taxes and the progressive U.S. tax system

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  • Gervais, Martin

Abstract

In life-cycle economies, where an individual's optimal consumption-work plan is almost never constant, the optimal marginal tax rates on capital and labor income vary with age. Conversely, the progressivity imbedded in the U.S. tax code implies that marginal tax rates vary with age because tax rates vary with earnings and earnings vary with age. Using numerical simulations, this paper shows that if the tax authority is prevented from conditioning tax rates on age, some degree of progressivity is desirable as progressive taxation better imitates optimal age-dependent taxes than an optimal age-independent tax system. This role for progressive taxation emanates from efficiency reasons and does not rely on any insurance nor re-distribution arguments Keywords; progressive taxation, optimal taxation, life-cycle

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Paper provided by Economics Division, School of Social Sciences, University of Southampton in its series Discussion Paper Series In Economics And Econometrics with number 0905.

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Date of creation: 01 Jan 2009
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Handle: RePEc:stn:sotoec:0905

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  1. Andres Erosa & Martin Gervais, 2001. "Optimal taxation in infinitely-lived agent and overlapping generations models : a review," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 23-44.
  2. Andres Erosa & Martin Gervais, 2000. "Optimal taxation in life-cycle economies," Working Paper, Federal Reserve Bank of Richmond 00-02, Federal Reserve Bank of Richmond.
  3. Juan Carlos Conesa & Dirk Krueger, 2002. "On the Optimal Progressivity of the Income Tax Code," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP), Centro de Altisimos Estudios Rios Perez (CAERP) 4, Centro de Altisimos Estudios Rios Perez (CAERP).
  4. Hansen, G D, 1993. "The Cyclical and Secular Behaviour of the Labour Input: Comparing Efficiency Units and Hours Worked," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 8(1), pages 71-80, Jan.-Marc.
  5. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  6. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report, Federal Reserve Bank of Minneapolis 251, Federal Reserve Bank of Minneapolis.
  7. Andrew Atkeson & V.V. Chari & Patrick J. Kehoe, 1999. "Taxing capital income: a bad idea," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-17.
  8. Erosa, Andres & Koreshkova, Tatyana, 2007. "Progressive taxation in a dynastic model of human capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(3), pages 667-685, April.
  9. Conesa, Juan Carlos & Kitao, Sagiri & Krueger, Dirk, 2006. "Taxing capital? Not a bad idea after all!," CFS Working Paper Series 2006/21, Center for Financial Studies (CFS).
  10. Sarte, Pierre-Daniel G., 1997. "Progressive taxation and income inequality in dynamic competitive equilibrium," Journal of Public Economics, Elsevier, Elsevier, vol. 66(1), pages 145-171, October.
  11. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 90(359), pages 529-49, September.
  12. Ana Castaneda & Javier Diaz-Gimenez & Jose-Victor Rios-Rull, 2003. "Accounting for the U.S. Earnings and Wealth Inequality," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 111(4), pages 818-857, August.
  13. Gouveia, Miguel & Strauss, Robert P., 1994. "Effective Federal Individual Tax Functions: An Exploratory Empirical Analysis," National Tax Journal, National Tax Association, vol. 47(2), pages 317-39, June.
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Cited by:
  1. Mathias Kifmann, 2004. "Age-dependent taxation and the optimal retirement benefit formula," Working Papers of the Research Group Heterogenous Labor, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim 04-20, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim.
  2. Echevarría, Cruz A., 2012. "Income tax progressivity, physical capital, aggregate uncertainty and long-run growth in an OLG economy," Journal of Macroeconomics, Elsevier, Elsevier, vol. 34(4), pages 955-974.
  3. Sagiri Kitao, 2010. "Labor-dependent capital income taxation that encourages work and saving," Staff Reports, Federal Reserve Bank of New York 435, Federal Reserve Bank of New York.
  4. Peter A. Diamond, 2009. "Taxes and Pensions," CESifo Working Paper Series 2636, CESifo Group Munich.
  5. William B. Peterman, 2011. "Determining the motives for a positive optimal tax on capital," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2011-55, Board of Governors of the Federal Reserve System (U.S.).
  6. Dirk Krueger & Alexander Ludwig, 2013. "Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation," PIER Working Paper Archive 13-035, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  7. Gorry, Aspen & Oberfield, Ezra, 2010. "Optimal Taxation over the Life Cycle," MPRA Paper 25297, University Library of Munich, Germany.
  8. Ruggero Paladini, 2014. "Da Bentham alla tassazione ottimale," Public Finance Research Papers, Istituto di Economia e Finanza, DIGEF, Sapienza University of Rome 2, Istituto di Economia e Finanza, DIGEF, Sapienza University of Rome.
  9. Julian Diaz Saavedra, 2013. "Age-dependent Taxation, Retirement Behavior, and Work Hours Over the Life Cycle," ThE Papers, Department of Economic Theory and Economic History of the University of Granada. 13/09, Department of Economic Theory and Economic History of the University of Granada..
  10. Kazi Iqbal & Stephen Turnovsky, 2007. "Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation," Working Papers, University of Washington, Department of Economics UWEC-2007-21-P, University of Washington, Department of Economics, revised Oct 2007.
  11. Kitao, Sagiri, 2010. "Labor-dependent capital income taxation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 57(8), pages 959-974, November.

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