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Designing Optimal Progressive Taxation with Hours Constraints

Author

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  • Kitae Cho

    (Yonsei University)

  • Eunseong Ma

    (Yonsei University)

Abstract

This paper investigates the effects of hours constraints on optimal progressive tax structures. To this end, we present a heterogeneous-agent model with a nonlinear progressive tax system. As a form of hours constraints, we introduce a wage penalty for those working below 40 hours per week, generating a realistic distribution of work hours predominantly concentrated at 40 hours. Our findings indicate that optimal tax progressivity should be significantly higher than the current level. Poor households benefit from the reform, while the rich experience welfare losses, primarily due to productive households being unable to adjust their labor supply under hours constraints. The optimal tax reform reduces overall inequality, albeit at the cost of decreased economic activity. Uncovering the Pareto weights in the social welfare functions, under the current tax system, the weight assigned to the richest households is approximately twice the average.

Suggested Citation

  • Kitae Cho & Eunseong Ma, 2024. "Designing Optimal Progressive Taxation with Hours Constraints," Working papers 2024rwp-231, Yonsei University, Yonsei Economics Research Institute.
    • Handle: RePEc:yon:wpaper:2024rwp-231
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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