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Optimal Progressive Income Taxation in a Bewley-Grossman Framework

Juergen Jung () and Chung Tran

No 2017-01, Working Papers from Towson University, Department of Economics

Abstract: We study the optimal progressivity of income taxation in a Bewley-Grossman model of health capital accumulation where individuals are exposed to earnings and health risks over the lifecycle. We impose the U.S. tax and transfer system and calibrate the model to match U.S. data. We then optimize the progressivity of the income tax code. The optimal income tax system is more progressive than current U.S. income taxes with zero taxes at the lower end of the income distribution and a marginal tax rate of over 50 percent for income earners above US$ 200,000. The Suits index—a Gini coefficient for the income tax contribution by income—is around 0.53 and much higher than 0.17 in the U.S. benchmark tax system. Welfare gains from switching to the optimal tax system amount to over 5 percent of compensating consumption. Moreover, we find that the structure of the health insurance system affects the degree of optimal progressivity of the income tax system. The introduction of Affordable Care Act in 2010—a program that redistributes wealth from high income and healthy types, to low income and sicker types—reduces the optimal progressivity level of the income tax system. Finally, we demonstrate that the optimal tax system is sensitive to the parametric specification of the income tax function and the transfer policy.

Keywords: Health risk; inequality; tax progressivity; Suits index; social insurance; optimal tax; general equilibrium. (search for similar items in EconPapers)
JEL-codes: E62 H24 I13 D52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-hea, nep-ias, nep-mac, nep-pbe and nep-pub
Date: 2017-03, Revised 2017-03
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