Discussion Paper Details

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Title: Optimal Progressivity with Age-Dependent Taxation

Author(s): Jonathan Heathcote, Kjetil Storesletten and Giovanni L. Violante

Publication Date: February 2019

Keyword(s): income distribution, incomplete markets, Labor Supply, Life Cycle, Skill investment and Tax progressivity

Programme Area(s): Macroeconomics and Growth and Public Economics

Abstract: This paper studies optimal taxation of earnings when the degree of tax progressivity is allowed to vary with age. The setting is an overlapping-generations model that incorporates irreversible skill investment, flexible labor supply, ex-ante heterogeneity in the disutility of work and the cost of skill acquisition, partially insurable wage risk, and a life cycle productivity profile. An analytically tractable version of the model without intertemporal trade is used to characterize and quantify the salient trade-offs in tax design. The key results are that progressivity should be U-shaped in age and that the average marginal tax rate should be increasing and concave in age. These findings are confirmed in a version of the model with borrowing and saving that we solve numerically.

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Bibliographic Reference

Heathcote, J, Storesletten, K and Violante, G. 2019. 'Optimal Progressivity with Age-Dependent Taxation'. London, Centre for Economic Policy Research.