How Do Tax Progressivity and Household Heterogeneity Affect Laffer Curves?

70 Pages Posted: 3 Apr 2014 Last revised: 11 Mar 2019

See all articles by Hans Aasnes Holter

Hans Aasnes Holter

University of Oslo - Department of Economics

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Serhiy Stepanchuk

Ecole Polytechnique Fédérale de Lausanne

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Date Written: March 8, 2019

Abstract

How much additional tax revenue can the government generate by increasing the level of labor income taxes? In this paper we argue that the degree of tax progressivity is a quantitatively important determinant of the answer to this question. To make this point we develop a large scale overlapping generations model with single and married households facing idiosyncratic income risk, extensive and intensive margins of labor supply, as well as endogenous accumulation of human capital through labor market experience. We calibrate the model to U.S. macro, micro and tax data and characterize the labor income tax Laffer curve for various degrees of tax progressivity. We find that the peak of the U.S. Laffer curve is attained at an average labor income tax rate of 58%. This peak (the maximal tax revenues the government can raise) increases by 7% if the current progressive tax code is replaced with a flat labor income tax. Replacing the current U.S. tax system with one that has Denmark'’s progressivity would lower the peak by 8%. We show that modeling the extensive margin of labor supply and endogenous human capital accumulation is crucial for these findings. With joint taxation of married couples (as in the U.S.), higher tax progressivity leads to significantly lower labor force participation of married women and substantially higher labor force participation of single women, an effect that is especially pronounced when future wages of females depend positively on past labor market experience.

Keywords: Laffer Curve, Progressive Taxation, Heterogeneous Households

JEL Classification: E62, H20, H60

Suggested Citation

Holter, Hans Aasnes and Krueger, Dirk and Stepanchuk, Serhiy, How Do Tax Progressivity and Household Heterogeneity Affect Laffer Curves? (March 8, 2019). PIER Working Paper No. 14-039, Available at SSRN: https://ssrn.com/abstract=2419154 or http://dx.doi.org/10.2139/ssrn.2419154

Hans Aasnes Holter (Contact Author)

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47-22855108 (Phone)

HOME PAGE: http://sites.google.com/site/hansaholter/

Dirk Krueger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6691 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Serhiy Stepanchuk

Ecole Polytechnique Fédérale de Lausanne ( email )

Station 5
Odyssea 1.04
1015 Lausanne, CH-1015
Switzerland

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