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Optimal Progressive Income Taxation in a Bewley-Grossman Framework

Listed author(s):
  • Juergen Jung

    ()

    (Department of Economics, Towson University)

  • Chung Tran

    ()

    (Research School of Economics, The Australian National University)

We study the optimal progressivity of income taxation in a Bewley-Grossman model of health capital accumulation where individuals are exposed to earnings and health risks over the lifecycle. We impose the U.S. tax and transfer system and calibrate the model to match U.S. data. We then optimize the progressivity of the income tax code. The optimal income tax system is more progressive than current U.S. income taxes with zero taxes at the lower end of the income distribution and a marginal tax rate of over 50 percent for income earners above US$ 200,000. The Suits index—a Gini coefficient for the income tax contribution by income—is around 0.53 and much higher than 0.17 in the U.S. benchmark tax system. Welfare gains from switching to the optimal tax system amount to over 5 percent of compensating consumption. Moreover, we find that the structure of the health insurance system affects the degree of optimal progressivity of the income tax system. The introduction of Affordable Care Act in 2010—a program that redistributes wealth from high income and healthy types, to low income and sicker types—reduces the optimal progressivity level of the income tax system. Finally, we demonstrate that the optimal tax system is sensitive to the parametric specification of the income tax function and the transfer policy.

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File URL: http://webapps.towson.edu/cbe/economics/workingpapers/2017-01.pdf
File Function: First version, 2017
Download Restriction: no

Paper provided by Towson University, Department of Economics in its series Working Papers with number 2017-01.

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Length: 46 pages
Date of creation: Mar 2017
Date of revision: Mar 2017
Handle: RePEc:tow:wpaper:2017-01
Contact details of provider: Postal:
Towson, Maryland 21252-0001

Phone: 410-704-2959
Fax: 410-704-3424
Web page: http://www.towson.edu/cbe/departments/economics/

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  1. Capatina, Elena, 2015. "Life-cycle effects of health risk," Journal of Monetary Economics, Elsevier, vol. 74(C), pages 67-88.
  2. 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, 02.
  3. 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.
  4. 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.
  5. Stefanie Stantcheva, 2015. "Optimal Taxation and Human Capital Policies over the Life Cycle," NBER Working Papers 21207, National Bureau of Economic Research, Inc.
  6. 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.
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