The Long Run Effects of Changes in Tax Progressivity

Abstract

This paper compares the steady state outcomes of revenue-neutral changes to the progressivity of the tax schedule. Our economy features heterogeneous households who differ in their preferences and permanent labor productivities, but it does not have idiosyncratic risk. We fi nd that increases in the progressivity of the tax schedule are associated with long-run distributions with greater aggregate income, wealth, and labor input. Average hours generally declines as the tax schedule becomes more progressive implying that the economy substitutes away from less productive workers toward more productive workers. Finally, as progressivity increases, income inequality is reduced and wealth inequality rises. Many of these results are qualitatively different than those found in models with idiosyncratic risk, and therefore suggest closer attention should be paid to modeling the insurance opportunities of households.

The Dynamics of Growth and Income Inequality under Progressive Taxation

“…Using a somewhat different approach, Carroll and Young () show how a progressive tax structure can also lead to a long‐run nondegenerate wealth distribution if agents have a common rate of time preference but are heterogeneous in their labor productivity. In a subsequent paper, Carroll and Young () analyze the long‐run effects of changes in tax progressivity on a number of aggregates, including distributional measures. Koyuncu () studies working hour patterns in the United States and Germany using a model that includes heterogeneity in both labor productivity and rates of time preference.…”

The Demand for Income Tax Progressivity in the Growth Model

“…The first difference between the baseline and fixed price economy is that with fixed factor prices progressivity receives even more support than in the baseline. As shown in Carroll and Young (2011), in this model environment, a higher rental rate implies higher long run income for every household with positive wealth, given the same marginal tax function.…”

“…One potentially interesting research topic would be to include some income uncertainty to the environment. Carroll and Young (2011) shows that the long-run consequences of progressive tax reforms can be qualitatively different depending upon whether heterogeneity arises from uninsurable income shocks as in Aiyagari (1994) or from permanent differences in preferences, labor productivity, and the disutility from labor. Adding uninsurable idiosyncratic labor productivity shocks to the model here would reduce the sensitivity of savings to taxation since households would have a precautionary saving motive as in Aiyagari (1994) so the impact of policy on factor prices could be quite different.…”

Progressive Tax and Inequality in a Unionized Economy*

“…The first stream is to do with the growth (output), welfare, and distributional analyses of progressive taxation. By focusing on aggregate income (output) and labor hours, some studies refer to the gains from flattening the tax code (e.g., Ventura 1999;Conesa et al 2009), while others stand in opposition to it (e.g., Carroll and Young, 2011). All of these papers abstract the endogenously determined growth rates from their frameworks.…”