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Optimal Progressive Income Taxation in a Bewley-Grossman Framework

Author

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  • Juergen Jung

    () (Department of Economics, Towson University)

  • Chung Tran

    () (Research School of Economics, The Australian National University)

Abstract

Abstract We study the optimal income tax progressivity in a Bewley-Grossman model where individuals are exposed to income and health risks over the lifecycle. Our results, based on a calibration for the US economy, indicate that the presence of health shocks requires the government to set higher optimal levels of tax progressivity in order to provide more social insurance for unhealthy low income individuals who have limited access to health insurance. The optimal progressive income tax system includes a tax break for income below $36,400 and high marginal tax rates of over 50 percent for income earners above $200,000. The tax progressivity (Suits) index—a Gini coefficient for income tax contributions by income—of the optimal tax system is around 0.53, compared to 0.17 in the benchmark tax system. Welfare gains from switching to the optimal tax system amount to over 5 percent of compensating lifetime consumption. The presence of health risk amplifies the social insurance role of the progressive income tax system. The optimal tax system in our model with health risk is more progressive than the optimal tax systems in models without health risk (e.g., Conesa and Krueger (2006) and Heathcote et al. (2017)). When health risk is removed from the model, the optimal tax system becomes less progressive and thus more similar to the optimal progressivity levels reported in the literature. In addition, the optimal level of tax progressivity is strongly affected by the design of the health insurance system.

Suggested Citation

  • Juergen Jung & Chung Tran, 2017. "Optimal Progressive Income Taxation in a Bewley-Grossman Framework," Working Papers 2017-01, Towson University, Department of Economics, revised Apr 2018.
  • Handle: RePEc:tow:wpaper:2017-01
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    File URL: http://webapps.towson.edu/cbe/economics/workingpapers/2017-01.pdf
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    References listed on IDEAS

    as
    1. Mark Huggett & Juan Carlos Parra, 2010. "How Well Does the U.S. Social Insurance System Provide Social Insurance?," Journal of Political Economy, University of Chicago Press, vol. 118(1), pages 76-112, February.
    2. Krueger, Dirk & Ludwig, Alexander, 2016. "On the optimal provision of social insurance: Progressive taxation versus education subsidies in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 77(C), pages 72-98.
    3. Capatina, Elena, 2015. "Life-cycle effects of health risk," Journal of Monetary Economics, Elsevier, vol. 74(C), pages 67-88.
    4. Juergen Jung & Chung Tran, 2016. "Market Inefficiency, Insurance Mandate and Welfare: U.S. Health Care Reform 2010," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 132-159, April.
    5. Yogo, Motohiro, 2016. "Portfolio choice in retirement: Health risk and the demand for annuities, housing, and risky assets," Journal of Monetary Economics, Elsevier, vol. 80(C), pages 17-34.
    6. Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
    7. Juergen Jung & Chung Tran, 2015. "Social Health Insurance: A Quantitative Exploration," ANU Working Papers in Economics and Econometrics 2015-629, Australian National University, College of Business and Economics, School of Economics.
    8. Stefanie Stantcheva, 2015. "Optimal Taxation and Human Capital Policies over the Life Cycle," NBER Working Papers 21207, National Bureau of Economic Research, Inc.
    9. Dahlia K. Remler & Jason E. Rachlin & Sherry A. Glied, 2001. "What can the take-up of other programs teach us about how to improve take-up of health insurance programs?," NBER Working Papers 8185, National Bureau of Economic Research, Inc.
    10. Juergen Jung & Chung Tran, 2008. "The Macroeconomics of Health Savings Accounts," Caepr Working Papers 2007-023, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    11. Juergen Jung & Chung Tran, 2016. "Market Inefficiency, Insurance Mandate and Welfare: U.S. Health Care Reform 2010," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 132-159, April.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Progressive Income Taxation in a Bewley-Grossman Framework
      by Christian Zimmermann in NEP-DGE blog on 2017-04-15 01:55:36

    More about this item

    Keywords

    Health risk; inequality; tax progressivity; Suits index; social insurance; optimal tax; general equilibrium.;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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