Tax and Education Policy in a Heterogeneous Agent Economy: What Levels of Redistribution Maximize Growth and Efficiency?

Abstract

This paper studies the effects of progressive income taxes and education finance in a dynamic heterogeneous agent economy. Such redistributive policies entail distortions to labor supply and savings, but also serve as partial substitutes for missing credit and insurance markets. The resulting tradeoffs for growth and efficiency are explored, both theoretically and quantitatively, in a model which yields complete analytical solutions. Progressive education finance always leads to higher income growth than taxes and transfers, but at the cost of lower insurance. Overall efficiency is assessed using a new measure which properly reflects aggregate resources and idiosyncratic risks but, unlike a standard social welfare function, does not reward equality per se. Simulations using empirical parameter estimates show that the efficiency costs and benefits of redistribution are generally of the same order of magnitude, resulting in reasonable values for the optimal rates.Aggregate income and aggregate welfare provide only very crude lower and upper bounds around the true efficiency tradeoff.

Productive government spending and its consequences for the growth–inequality tradeoff

“…Though these are extreme forms of market incompleteness, adopted to maximize tractability and transparency, what matters is the existence of some forms of incompleteness; see, e.g., Aghion et al (1999), Bénabou (2000 and2002). In this respect we view our analysis as being particularly relevant for developing economies.…”

“…The coefficient  can be viewed as reflecting two elements: (i) the tradeoff in utility between its own consumption vs. bequests, reflecting the "joy of giving" and (ii) some intertemporal discounting due to the fact that the bequests 7 This type of individual entrepreneurship is common in models with incomplete markets (see, for e.g., Loury, 1981, Bénabou, 2000, 2002and Angeletos and Calvet, 2005 (1 )…”

“…3 The equilibrium dynamics has a simple recursive structure. The dynamics of inequality drives the growth of the aggregate variables -private capital, public capital, and outputbut not vice versa.There are no credit or insurance markets, the absence of which is a key element generating inequality, as in Loury (1981), and Bénabou (2000, 2002. When individuals cannot fully insure themselves from future income uncertainty and are unable to borrow or lend unlimited amounts, inequality associated with the idiosyncratic productivity shocks persists.…”

“…First, is the literature on public capital and endogenous growth, some of which is referred to earlier. Second, are papers studying distribution and growth with imperfect credit markets, (e.g., Loury, 1981, Galor and Zeira, 1993, Aghion and Bolton, 5 1997, Aghion, et al, 1999, Bénabou, 1996, 2000, 2002, and Seshadri and Yuki, 2004). …”

Capital Taxation with Entrepreneurial Risk

“…Some examples in this area include Li (2002), Domeij and Heathcote (2003), Meh (2005), Cagetti and DeNardi (2007), and Kitao (2007). Benabou (2002) develops a tractable dynamic general-equilibrium model of human capital accumulation with endogenous effort and missing credit and insurance markets.…”