Quantifying the Welfare Gains from History Dependent Income Taxation
No 271, 2017 Meeting Papers from Society for Economic Dynamics
I quantify the welfare gains from introducing history dependent income tax in an incomplete markets framework where individuals face uninsurable random walk idiosyncratic shocks. I assume that the income tax paid is a function of a geometrical weighted average of past incomes, and solve for the optimal weights. I find that the optimal weights on past incomes decline geometrically at a rate equal to the discount rate. The welfare gains from history dependence are large, about 1.77 percent of consumption. I decompose the total effect into an efficiency effect that increases labor supply, and an insurance effect that reduces volatility of consumption and find that, quantitatively, the insurance effect dominates the efficiency effect. The optimal tax increases consumption insurance by trading higher tax progressivity with repect to past incomes for a reduced tax progressivity with respect to the current income.
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More papers in 2017 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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