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Optimal Progressive Income Taxation in a Bewley-Grossman Framework

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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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    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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