Evolution of Tax Progressivity in the U.S.: New Estimates and Welfare Implications

We provide a statistical description of the evolution of tax progressivity and income inequality in the U.S. for the period 1960-2008, using tax revenue data. We document a large and steady increase of tax progressivity over our sample, with brief exceptions during the early 1980’s and early 2000’s. We provide flexible – parametric and non-parametric – yearly estimates of the tax distribution. We then use a canonical heterogeneous households model (Aiyagari, 1994) to compare the optimal tax progressivity to the current U.S. tax system. Our findings are threefold. First, under the joint assumptions of a linear capital capital tax and an intensive labor supply choice, the optimal progressivity is very close to the one measured in the data. However, if the labor supply choice is on the extensive margin only, optimal tax progressivity is much larger than in the data. Third, preliminary results suggest that the optimal tax system should allow for a non-zero cross-term between capital and labor income taxes: there are welfare gains in allowing the marginal capital tax rate to be increasing in labor income.