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Optimal labor income taxation and asset distribution in an economy with no insurance market and extensive labor supply responses

Takao Kataoka () and Yoshihiro Takamatsu ()
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Takao Kataoka: Waseda University
Yoshihiro Takamatsu: Meiji Gakuin University

International Tax and Public Finance, 2024, vol. 31, issue 6, No 7, 1639 pages

Abstract: Abstract We examine the effects of stationary nonlinear labor income tax rules in a dynamic economy, considering extensive marginal labor-leisure choices and uninsured idiosyncratic shocks on labor productivity and labor disutility. The labor income tax rule has significant implications for households’ savings behavior and asset distribution over the long-run. We derive a optimal stationary tax rules as a natural extension of optimal participation tax rule in the static models. Through numerical simulations, two main findings emerge: (i) The current optimal tax rule, aimed at maximizing welfare based on the present asset distribution level, supports in-work benefits for low-income workers as a static extensive margin model. While this policy temporarily enhances welfare, it leads to a decline in capital accumulation and a decrease in average utility flow over time. (ii) The long-run optimal tax rule, optimizing welfare when the asset distribution reaches a stationary state, exhibits less progressivity and initially worsens welfare temporarily. However, it eventually improves the average utility flow in the long-run. The long-term consequences of households’ saving behavior and asset distribution mitigate the attractiveness of in-work benefit policies. By shedding light on the trade-offs between short-term welfare gains and long-term utility improvements, this study provides insights into designing effective labor income tax policies in a dynamic economic context.

Keywords: Optimal labor income taxation; Asset distribution; Extensive labor margin; In-work benefits (search for similar items in EconPapers)
JEL-codes: E21 H21 H24 I38 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s10797-023-09819-4

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