On the Optimal Progressivity of the Income Tax Code

Juan Carlos Conesa and Dirk Krueger

No 11044, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E62 H21 H24 (search for similar items in EconPapers)
Date: 2005-01
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pub
Note: PE
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Citations: View citations in EconPapers (20)

Published as Conesa, Juan Carlos & Krueger, Dirk, 2006. "On the optimal progressivity of the income tax code," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1425-1450, October.

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Related works:
Working Paper: On the Optimal Progressivity of the Income Tax Code (2015)
Journal Article: On the optimal progressivity of the income tax code (2006)
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)
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