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Optimal Redistribution in an Open Economy

  • Oleg Itskhoki

    (Harvard University)

Conventional wisdom suggests that the optimal policy response to rising income inequality is greater redistribution via higher marginal tax rates and more progressive tax schedules. In this paper we study an economy in which trade is associated with a costly entry into the foreign market, so that only the most productive agents can profitably participate in foreign trade. In this model, trade integration simultaneously leads to rising income inequality and a more sensitive efficiency margin of taxation, both driven by the extensive margin of trade. As a result, the optimal policy response may be to reduce the marginal taxes, thereby further increasing inequality. In order to reap most of the welfare gains from trade, countries may need to accept increasing income inequality.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 967.

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Date of creation: 2009
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Handle: RePEc:red:sed009:967
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  1. Attanasio, Orazio & Goldberg, Pinelopi K. & Pavcnik, Nina, 2004. "Trade reforms and wage inequality in Colombia," Journal of Development Economics, Elsevier, vol. 74(2), pages 331-366, August.
  2. Carl Davidson & Steven Matusz, 2005. "Trade Liberalization and Compensation," International Trade 0503008, EconWPA.
  3. Andrew B. Bernard & Jonathan Eaton & J. Bradford Jenson & Samuel Kortum, 2000. "Plants and Productivity in International Trade," NBER Working Papers 7688, National Bureau of Economic Research, Inc.
  4. Levinsohn, James, 1999. "Employment responses to international liberalization in Chile," Journal of International Economics, Elsevier, vol. 47(2), pages 321-344, April.
  5. Paolo Epifani & Gino Gancia, 2008. "Openness, Government Size and the Terms of Trade," IEW - Working Papers 359, Institute for Empirical Research in Economics - University of Zurich.
  6. Elhanan Helpman & Oleg Itshoki & Stephen Redding, 2009. "Inequality and unemployment in a global economy," LSE Research Online Documents on Economics 25501, London School of Economics and Political Science, LSE Library.
  7. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," Boston College Working Papers in Economics 593, Boston College Department of Economics.
  8. Giulia Faggio & Kjell G. Salvanes & John Van Reenen, 2007. "The evolution of inequality in productivity and wages: panel data evidence," LSE Research Online Documents on Economics 4558, London School of Economics and Political Science, LSE Library.
  9. Elhanan Helpman & Oleg Itskhoki & Stephen Redding, 2008. "Wages, Unemployment and Inequality with Heterogeneous Firms and Workers," NBER Working Papers 14122, National Bureau of Economic Research, Inc.
  10. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting Trade: Firms, Industries, and Export Destinations," NBER Working Papers 10344, National Bureau of Economic Research, Inc.
  11. Tuomala, Matti, 1990. "Optimal Income Tax and Redistribution," OUP Catalogue, Oxford University Press, number 9780198286059, March.
  12. Spector, David, 2001. "Is it possible to redistribute the gains from trade using income taxation?," Journal of International Economics, Elsevier, vol. 55(2), pages 441-460, December.
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