Optimal Taxation in Life-Cycle Economies

FRB Richmond Working Paper No. 00-2

48 Pages Posted: 27 Nov 2012

See all articles by Andres Erosa

Andres Erosa

University of Toronto - Department of Economics

Martin Gervais

University of Iowa; IFS

Date Written: September 1, 2000

Abstract

We use a very standard life-cycle growth model, in which individuals have a labor-leisure choice in each period of their lives, to prove that an optimizing government will almost always find it optimal to tax or subsidize interest income. The intuition for our result is straightforward. In a life-cycle model the individual’s optimal consumption-work plan is almost never constant and an optimizing government almost always taxes consumption goods and labor earnings at different rates over an individual’s lifetime. One way to achieve this goal is to use capital and labor income taxes that vary with age. If tax rates cannot be conditioned on age, a non-zero tax on capital income is also optimal, as it can (imperfectly) mimic age-conditioned consumption and labor income tax rates.

Keywords: optimal taxation, uniform taxation, life cycle

JEL Classification: E62, H21

Suggested Citation

Erosa, Andres and Gervais, Martin, Optimal Taxation in Life-Cycle Economies (September 1, 2000). FRB Richmond Working Paper No. 00-2, Available at SSRN: https://ssrn.com/abstract=2126760 or http://dx.doi.org/10.2139/ssrn.2126760

Andres Erosa

University of Toronto - Department of Economics ( email )

150 St. George Street
Toronto, Ontario M5S 3G7
Canada

Martin Gervais (Contact Author)

University of Iowa ( email )

108 Pappajohn Building
Iowa City, IA 52242
United States

IFS ( email )

7 Ridgmount Street
London, WC1E 7AE
United Kingdom

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