Optimal Tax Progressivity: An Analytical Framework

Jonathan Heathcote, Kjetil Storesletten and Giovanni L. Violante

No 496, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, and aggravates the externality associated with valued public expenditures. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preferences, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the externality linked to valued government purchases play quantitatively similar roles in limiting desired progressivity.

Keywords: Skill investment; Partial insurance; Welfare; Progressivity; Income distribution; Labor supply; Valued government expenditures (search for similar items in EconPapers)
JEL-codes: D30 E20 H20 H40 J22 J24 (search for similar items in EconPapers)
Pages: 76 pages
Date: 2014-01-31
New Economics Papers: this item is included in nep-dge, nep-ias, nep-mac, nep-pbe, nep-pub and nep-sog
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (43)

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Related works:
Journal Article: Optimal Tax Progressivity: An Analytical Framework (2017)
Working Paper: Optimal Tax Progressivity: An Analytical Framework (2014)
Working Paper: Optimal tax progressivity: an analytical framework (2014)
Working Paper: Optimal Tax Progressivity: An Analytical Framework (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:496

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