The Case for a Progressive Tax: From Basic Research to Policy Recommendations

45 Pages Posted: 24 Aug 2011  

Peter A. Diamond

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Emmanuel Saez

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 24, 2011

Abstract

This paper presents the case for tax progressivity based on recent results in optimal tax theory. We consider the optimal progressivity of earnings taxation and whether capital income should be taxed. We critically discuss the academic research on these topics and when and how the results can be used for policy recommendations. We argue that a result from basic research is relevant for policy only if (a) it is based on economic mechanisms that are empirically relevant and first order to the problem, (b) it is reasonably robust to changes in the modeling assumptions, (c) the policy prescription is implementable (i.e., is socially acceptable and is not too complex). We obtain three policy recommendations from basic research that satisfy these criteria reasonably well. First, very high earners should be subject to high and rising marginal tax rates on earnings. Second, low income families should be encouraged to work with earnings subsidies, which should then be phased-out with high implicit marginal tax rates. Third, capital income should be taxed. We explain why the famous zero marginal tax rate result for the top earner in the Mirrlees model and the zero capital income tax rate results of Chamley-Judd and Atkinson-Stiglitz are not policy relevant in our view.

Keywords: optimal taxation

JEL Classification: H210

Suggested Citation

Diamond, Peter A. and Saez, Emmanuel, The Case for a Progressive Tax: From Basic Research to Policy Recommendations (August 24, 2011). CESifo Working Paper Series No. 3548. Available at SSRN: https://ssrn.com/abstract=1915957

Peter A. Diamond

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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CESifo (Center for Economic Studies and Ifo Institute) ( email )

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Emmanuel Saez (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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