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Reforming labor income tax progressivity during demographic transition: Welfare effects in Korea

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  • Woo, Jinhee

Abstract

This paper analyzes the macroeconomic and welfare effects of reforming labor income tax progressivity during Korea’s demographic transition. Korea faces rapid population aging, with the old-age dependency ratio projected to increase from 26% in 2020 to more than 115% by 2070. Fiscal pressures intensify because an unusually large share of low-income earners face near-zero effective tax rates, creating a narrow and inefficient tax base. Using a heterogeneous-agent overlapping generations model calibrated to the Korean economy and incorporating transition dynamics, we identify the level of tax progressivity that maximizes aggregate welfare across all affected generations. The optimal system features markedly lower progressivity than the current system and delivers welfare gains equivalent to a permanent 0.8% increase in consumption relative to initial steady-state levels. These results show that excessive progressivity during demographic transition accelerates tax base erosion and reduces both output and social welfare.

Suggested Citation

  • Woo, Jinhee, 2026. "Reforming labor income tax progressivity during demographic transition: Welfare effects in Korea," Economic Modelling, Elsevier, vol. 158(C).
    • Handle: RePEc:eee:ecmode:v:158:y:2026:i:c:s0264999326000659
    DOI: 10.1016/j.econmod.2026.107536
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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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