The Long Run Effects of Changes in Tax Progressivity

45 Pages Posted: 24 Apr 2010 Last revised: 28 Aug 2010

See all articles by Daniel Carroll

Daniel Carroll

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Eric R. Young

University of Virginia

Date Written: December 22, 2009

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 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

Carroll, Daniel and Young, Eric R., The Long Run Effects of Changes in Tax Progressivity (December 22, 2009). FRB of Cleveland Working Paper No. 09-13, Available at SSRN: https://ssrn.com/abstract=1595070

Daniel Carroll (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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