Designing Optimal Progressive Taxation with Hours Constraints

Kitae Cho and Eunseong Ma
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Kitae Cho: Yonsei University

No 2024rwp-231, Working papers from Yonsei University, Yonsei Economics Research Institute

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.

Keywords: hours constraints; optimal tax progressivity; labor supply elasticity; redistribution (search for similar items in EconPapers)
JEL-codes: E21 H21 H23 J22 (search for similar items in EconPapers)
Pages: 41pages
Date: 2024-09
New Economics Papers: this item is included in nep-dge, nep-lma, nep-pbe and nep-pub
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