Redistributive Policies through Taxation: Theory and Evidence

Charles Grant, Christos Koulovatianos, Alexander Michaelides and Mario Padula

No ECO2003/13, Economics Working Papers from European University Institute

Abstract: Increasing marginal tax rates and making payments to the poor reduce inequality and introduce savings dis-incentives. Using a heterogeneous agent model with incomplete markets, we show that higher taxes (and transfers) decrease consumption inequality but also mean savings and mean consumption. This demonstrates the trade-off between equity and efficiency. These theoretical predictions are tested by exploiting differences in tax rates across US states. Using two surveys, the Consumer Expenditure Survey and the Current Population Survey, we show that the empirical evidence supports the theory, and that there is a comparatively small fall in efficiency for a given gain in equity associated with higher taxation.

Keywords: Undiversifiable earnings risk; tax distortions; equity; efficiency; transfers (search for similar items in EconPapers)
JEL-codes: E21 H20 H31 (search for similar items in EconPapers)
Date: 2003
New Economics Papers: this item is included in nep-pbe
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Citations: View citations in EconPapers (2)

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Working Paper: Redistributive Policies through Taxation: Theory and Evidence (2003)
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