Optimal Tax Progressivity An Analytical Framework Jonathan Heathcote,Kjetil Storesletten, Giovanni L. Violante
By: Heathcote, Jonathan
.
Contributor(s): Storesletten, Kjetil | Violante, Giovanni L.
Material type: 
ArticlePublisher: 2017Subject(s): IMPOSICION OPTIMA | IMPUESTOS | PROGRESIVIDAD | MODELOS ECONOMETRICOS
In:
The Quarterly Journal of Economics v. 132, n. 532, issue 4, November 2017, p. 1693-1754Summary: 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. On the other hand, progressivity reduces incentives to work and toinvest in skills, distortions that are especially costly when the government mustfinance public goods. 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 preference, 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 desire to finance government purchases play quantitatively similar roles in limitingoptimal progressivity. In a version of the model where poverty constrains skill investment, optimal progressivity is close to the U.S. value. An empirical analysis on cross-country data offers support to the theory.
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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. On the other hand, progressivity reduces incentives to work and toinvest in skills, distortions that are especially costly when the government mustfinance public goods. 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 preference, 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 desire to finance government purchases play quantitatively similar roles in limitingoptimal progressivity. In a version of the model where poverty constrains skill investment, optimal progressivity is close to the U.S. value. An empirical analysis on cross-country data offers support to the theory.
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