On the Optimal Progressivity of the Income Tax Code

Juan Carlos Conesa () and Dirk Krueger ()

No 2005/10, CFS Working Paper Series from Center for Financial Studies

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 off against the efficiency loss arising from distorting endogenous labor supply and capital accumulation decisions. 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 17:2% and a fixed deduction of about $9,400. The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 1:7% 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 that a majority of the population currently alive (roughly 62%) would experience welfare gains, suggesting that such fundamental income tax reform is not only desirable, but may also be politically feasible.

Keywords: Progressive Taxation; Optimal Taxation; Flat Taxes; 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, nep-mac, nep-pbe and nep-pub
Date: 2005-01-10
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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 (2002)
Journal Article: On the optimal progressivity of the income tax code (2006)
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