Optimal Progressivity with Age-Dependent Taxation

Jonathan Heathcote, Kjetil Storesletten and Giovanni L. Violante

No 551, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: This paper studies optimal taxation of labor earnings when the degree of tax progressivity is allowed to vary with age. We analyze this question in a tractable equilibrium overlapping-generations model that incorporates a number of salient trade-offs in tax design. Tax progressivity provides insurance against ex-ante heterogeneity and earnings uncertainty that missing markets fail to deliver. However, taxes distort labor supply and human capital investments. Uninsurable risk cumulates over the life cycle, and thus the welfare gains from income compression via progressive taxation increase with age. On the other hand, average labor productivity rises with age, and thus the welfare losses from progressive taxation's distortionary impact on labor supply also increase with age. The optimal age-varying system balances these distortions. In a calibrated version of the economy, we quantify the welfare gains of moving from the optimal age-invariant to the optimal age-dependent system and find that they are negligible.

Keywords: Government expenditures; Partial insurance; Labor supply; Skill investment; Tax progressivity; Tagging; Income distribution; Welfare (search for similar items in EconPapers)
JEL-codes: D30 E20 H20 H40 J22 J24 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2017-08-04
New Economics Papers: this item is included in nep-dge, nep-ias, nep-lma and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Optimal progressivity with age-dependent taxation (2020)
Working Paper: Optimal Progressivity with Age-Dependent Taxation (2019)
Working Paper: Optimal Progressivity with Age-Dependent Taxation (2019)
Working Paper: Optimal Progressivity with Age-Dependent Taxation (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:551

DOI: 10.21034/sr.551

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