The Long Run Effects of Changes in Tax Progressivity
45 Pages Posted: 24 Apr 2010 Last revised: 28 Aug 2010
Date Written: December 22, 2009
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 find 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.
Keywords: heterogeneity, progressive taxation, complete markets
JEL Classification: E21, E25, E62
Suggested Citation: Suggested Citation