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On the Optimality of Progressive Income Redistribution

  • OZAN, Bakis
  • KAYMAK, Baris

We compute the optimal non-linear tax policy for a dynastic economy with uninsurable risk, where generations are linked by dynastic wealth accumulation and correlated incomes. Unlike earlier studies, we find that the optimal long-run tax policy is moderately regressive. Regressive taxes lead to higher output and consumption, at the expense of larger after-tax income inequality. Nevertheless, equilibrium effects and the availability of self-insurance via bequests mitigate the impact of regressive taxes on consumption inequality, resulting in improved average welfare overall. We also consider the optimal once-and-for-all change in the tax system, taking into account the transition dynamics. Starting at the U.S. status quo, the optimal tax reform is slightly more progressive than the current system.

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Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 2012-09.

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Length: 42 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:mtl:montde:2012-09
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  1. Saez, Emmanuel, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Wiley Blackwell, vol. 68(1), pages 205-29, January.
  2. Juan Carlos Conesa & Dirk Krueger, 2004. "On the Optimal Progressivity of the Income Tax Code," Working Papers 131, Barcelona Graduate School of Economics.
  3. Haider, Steven J, 2001. "Earnings Instability and Earnings Inequality of Males in the United States: 1967-1991," Journal of Labor Economics, University of Chicago Press, vol. 19(4), pages 799-836, October.
  4. Daniel Feenberg & Elisabeth Coutts, 1993. "An introduction to the TAXSIM model," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(1), pages 189-194.
  5. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  6. Erosa, Andres & Koreshkova, Tatyana, 2007. "Progressive taxation in a dynastic model of human capital," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 667-685, April.
  7. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March.
  8. Tsyvinski, A. & Golosov, M., 2004. "Optimal Taxation with Endogenous Insurance Markets," 2004 Meeting Papers 124, Society for Economic Dynamics.
  9. repec:tpr:qjecon:v:111:y:1996:i:2:p:391-430 is not listed on IDEAS
  10. Kjetil Storesletten & Gianluca Violante & Jonathan Heathcote, 2012. "Redistributive Taxation in a Partial Insurance Economy," 2012 Meeting Papers 588, Society for Economic Dynamics.
  11. David M. Cutler & Jonathan Gruber, 1995. "Does Public Insurance Crowd Out Private Insurance?," NBER Working Papers 5082, National Bureau of Economic Research, Inc.
  12. Krueger, Dirk & Perri, Fabrizio, 2010. "Public versus Private Risk Sharing," CEPR Discussion Papers 7625, C.E.P.R. Discussion Papers.
  13. Seshadri, Ananth & Yuki, Kazuhiro, 2004. "Equity and efficiency effects of redistributive policies," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1415-1447, October.
  14. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  15. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2000. "Consumption and Risk Sharing Over the Life Cycle," NBER Working Papers 7995, National Bureau of Economic Research, Inc.
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