Distributional tax analysis in theory and practice: Harberger meets Diamond-Mirrlees

This paper proposes a new framework to study the distribution of current taxes and the effects of tax reforms. For current taxes, labor taxes are assigned to the corresponding workers, capital taxes to the corresponding asset owners, and consumption taxes to the corresponding consumers. Current taxes capture the wedges between pre-tax prices (relevant for production) and after-tax prices (relevant for the work, saving, and consumption decisions of households) as well as the direct equity effects of taxes while being silent about efficiency. Our method does not require structural assumptions, is internally consistent, and maximizes the comparability of tax progressivity and inequality over time and across countries. Applying this methodology to the United States, we find that the effective tax rate of the top 1% has declined from about 50% in the early 1950s to 32% in 2021. It is through the corporate tax that a high degree of tax progressivity was achieved in the middle of the 20th century. To analyze the distributional effects of tax reforms, mechanical changes in tax liability by income groups and aggregate revenue effects due to household (but not firms’) behavioral responses are sufficient statistics in the neoclassical optimal tax model of Diamond and Mirrlees (1971). The effects of taxes on pre-tax prices at the heart of classical tax incidence analysis are normatively irrelevant.