DP13550 Optimal Progressivity with Age-Dependent Taxation

Author(s): Jonathan Heathcote, Kjetil Storesletten, Giovanni L. Violante
Publication Date: February 2019
Keyword(s): income distribution, incomplete markets, Labor Supply, Life Cycle, Skill investment, Tax progressivity
JEL(s): D30, E20, H20, H40, J22, J24
Programme Areas: Public Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13550

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.