On the Optimal Progressivity of the Income Tax Code

Juan Carlos Conesa () and Dirk Krueger ()

No 4, Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) from Centro de Altisimos Estudios Rios Perez (CAERP)

Abstract: This paper computes the optimal progressivity of the income tax code in a dynamic general equilibrium model with household heterogeneity in which uninsurable labor productivity risk gives rise to a nontrivial income and wealth distribution. A progressive tax system serves as a partial substitute for missing insurance markets and enhances an equal distribution of economic welfare. These beneficial effects of a progressive tax system have to be traded o¤ against the e¢ciency loss arising from distorting endogenous labor supply and capital accumulation decisions. A determination of the optimal progressivity of the income tax code therefore calls for a quantitative exploration. Using a utilitarian steady state social welfare criterion we find that the optimal US income tax is well approximated by a flat tax rate of 19.5% and a fixed deduction of about $3,700: The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 0.4% higher consumption in each state of the world. An explicit computation of the transition path induced by a reform of the current towards the optimal tax system indicates, however, that a majority of the population currently alive would suffer welfare losses, calling into question the political feasibility of such fundamental income tax reform.

Keywords: Progressive Taxation; Optimal Taxation; Social Insurance; Transition (search for similar items in EconPapers)
JEL-codes: E62 H21 H24 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge
Date: 2002-06
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Related works:
Working Paper: On the Optimal Progressivity of the Income Tax Code (2005)
Working Paper: On the Optimal Progressivity of the Income Tax Code (2005)
Working Paper: On the Optimal Progressivity of the Income Tax Code (2005)
Journal Article: On the optimal progressivity of the income tax code (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:cae:caerpp:4

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