| Abstract: |
This paper computes the optimal progressivity of the income tax code in a
dynamic general equilibrium model with household heterogeneity in which
uninsurable labor 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
labor 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. |