On the Optimal Progressivity of the Income Tax Code

Juan Carlos Conesa and Dirk Krueger

No 5040, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper computes the optimal progressivity of the income tax code in a dynamic general equilibrium model with household heterogeneity in which uninsurable labour 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 labour 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)
Date: 2005-05
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
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Citations: View citations in EconPapers (20)

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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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