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High Marginal Tax Rates on the Top 1%? Lessons from a Life Cycle Model with Idiosyncratic Income Risk

  • Kindermann, Fabian
  • Krueger, Dirk

In this paper we argue that very high marginal labor income tax rates are an effective tool for social insurance even when households have preferences with high labor supply elasticity, make dynamic savings decisions, and policies have general equilibrium effects. To make this point we construct a large scale Overlapping Generations Model with uninsurable labor productivity risk, show that it has a wealth distribution that matches the data well, and then use it to characterize fiscal policies that achieve a desired degree of redistribution in society. We find that marginal tax rates on the top 1% of the earnings distribution of close to 90% are optimal. We document that this result is robust to plausible variation in the labor supply elasticity and holds regardless of whether social welfare is measured at the steady state only or includes transitional generations.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 10208.

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Date of creation: Oct 2014
Handle: RePEc:cpr:ceprdp:10208
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  1. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
  2. Holter, Hans A. & Krueger, Dirk & Stepanchuk, Serhiy, 2014. "How Does Tax Progressivity and Household Heterogeneity Affect Laffer Curves?," CEPR Discussion Papers 10259, C.E.P.R. Discussion Papers.
  3. Mark Huggett & Alejandro Badel, 2014. "Taxing Top Earners: A Human Capital Perspective," Working Papers gueconwpa~14-14-02, Georgetown University, Department of Economics.
  4. OZAN, Bakis & KAYMAK, Baris, 2012. "On the Optimality of Progressive Income Redistribution," Cahiers de recherche 2012-09, Universite de Montreal, Departement de sciences economiques.
  5. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, 05.
  6. Guner, Nezih & Lopez-Daneri, Martin & Ventura, Gustavo, 2014. "Heterogeneity and Government Revenues: Higher Taxes at the Top?," CEPR Discussion Papers 10071, C.E.P.R. Discussion Papers.
  7. Hans Fehr & Fabian Kindermann, 2012. "Optimal Taxation with Current and Future Cohorts," CESifo Working Paper Series 3973, CESifo Group Munich.
  8. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2007. "Taxing Capital? Not a Bad Idea After All!," NBER Working Papers 12880, National Bureau of Economic Research, Inc.
  9. Javier Díaz-Giménez & Andrew Glover & José-Víctor Ríos-Rull, 2011. "Facts on the distributions of earnings, income, and wealth in the United States: 2007 update," Quarterly Review, Federal Reserve Bank of Minneapolis, pages -.
  10. Facundo Alvaredo & Anthony B. Atkinson & Thomas Piketty & Emmanuel Saez, 2013. "The Top 1 Percent in International and Historical Perspective," NBER Working Papers 19075, National Bureau of Economic Research, Inc.
  11. Peter A. Diamond & Emmanuel Saez, 2011. "The Case for a Progressive Tax: From Basic Research to Policy Recommendations," CESifo Working Paper Series 3548, CESifo Group Munich.
  12. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  13. Bas Jacobs & Dirk Schindler, 2012. "On the Desirability of Taxing Capital Income in Optimal Social Insurance," Working Paper Series of the Department of Economics, University of Konstanz 2012-02, Department of Economics, University of Konstanz.
  14. Emmanuel Saez, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Oxford University Press, vol. 68(1), pages 205-229.
  15. Hsu, Minchung & Yang, C.C., 2013. "Optimal linear and two-bracket income taxes with idiosyncratic earnings risk," Journal of Public Economics, Elsevier, vol. 105(C), pages 58-71.
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