Optimal age-dependent taxation in emerging markets: A quantitative assessment

This paper studies the design and welfare implications of an optimal age-dependent taxation scheme for an emerging economy. The setting is an overlapping generations economy with uninsured productivity risk, partially insured occupational risk (unemployment and informality by exclusion), stochastic retirement, and stochastic access to the pension fund. We calibrate this model for Ecuador and find that the optimal tax scheme provides a payroll tax exemption up to age 35, thereafter becoming hump-shaped with a maximum tax rate of 50% at age 50. The progressive tax levied on labor income implies an initial marginal tax rate of 5% that increases linearly to a top marginal tax rate of 35%. This tax scheme produces a welfare gain of 2.9% measured in compensated equivalent units and reduces wealth inequality by 5.8%. For comparison, in a model built and calibrated for the US economy (no informality, higher productivity and longevity risk, and full coverage of the social security system), the optimal payroll tax implies a zero tax rate up to age 27, becoming hump-shaped thereafter with a maximum tax rate of 56.2% at age 46.