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On the optimal design of transfers and income-tax progressivity

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Abstract

We study the optimal design of means-tested transfers and progressive income taxes. In a simple analytical model, we demonstrate an optimally negative relation between transfers and income-tax progressivity due to efficiency and redistribution concerns. In a rich dynamic model, we quantify the optimal plan with flexible tax-and-transfer functions. Transfers should be larger than currently in the U.S. and financed with moderate income-tax progressivity. Transfers are key to implement higher progressivity in average than in marginal tax-and-transfer rates, achieving redistribution while preserving efficiency. Quantitatively, the left tail of the income distribution determines optimal transfers, whereas the right tail determines income-tax progressivity.

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  • Axelle Ferrière & Philipp Grübener & Gaston Navarro & Oliko Vardishvili, 2022. "On the optimal design of transfers and income-tax progressivity," International Finance Discussion Papers 1350, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1350
    DOI: 10.17016/IFDP.2022.1350
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    Cited by:

    1. Rauh, Christopher & Rodrigues dos Santos, Marcelo, 2022. "How do transfers and universal basic income impact the labor market and inequality?," CEPR Discussion Papers 16993, C.E.P.R. Discussion Papers.
    2. Chung Tran & Nabeeh Zakariyya, 2023. "Progressive Pension and Optimal Tax Progressivity," ANU Working Papers in Economics and Econometrics 2023-691, Australian National University, College of Business and Economics, School of Economics.

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    More about this item

    Keywords

    Heterogeneous Agents; Fiscal Policy; Optimal Taxation; Redistribution;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H53 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Welfare Programs

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