How Does Tax Progressivity and Household Heterogeneity Affect Laffer Curves?

CFS Working Paper No. 490

58 Pages Posted: 13 Nov 2014

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: November 9, 2014

Abstract

How much additional tax revenue can the government generate by increasing labor income taxes? In this paper we provide a quantitative answer to this question, and study the importance of the progressivity of the tax schedule for the ability of the government to generate tax revenues. We develop a rich overlapping generations model featuring an explicit family structure, extensive and intensive margins of labor supply, endogenous accumulation of labor market experience as well as standard intertemporal consumption-savings choices in the presence of uninsurable idiosyncratic labor productivity risk. We calibrate the model to US macro, micro and tax data and characterize the labor income tax Laffer curve under the current choice of the progressivity of the labor income tax code as well as when varying progressivity. We find that more progressive labor income taxes significantly reduce tax revenues. For the US, converting to a flat tax code raises the peak of the Laffer curve by 6%, whereas converting to a tax system with progressivity similar to Denmark would lower the peak by 7%. We also show that, relative to a representative agent economy tax revenues are less sensitive to the progressivity of the tax code in our economy. This finding is due to the fact that labor supply of two earner households is less elastic (along the intensive margin) and the endogenous accumulation of labor market experience makes labor supply of females less elastic (around the extensive margin) to changes in tax progressivity.

Keywords: Progressive Taxation, Fiscal Policy, Laff er Curve, Government Debt

JEL Classification: E62, H20, H60

Suggested Citation

Holter, Hans Aasnes and Krueger, Dirk and Stepanchuk, Serhiy, How Does Tax Progressivity and Household Heterogeneity Affect Laffer Curves? (November 9, 2014). CFS Working Paper No. 490. Available at SSRN: https://ssrn.com/abstract=2523364 or http://dx.doi.org/10.2139/ssrn.2523364

Hans Aasnes Holter

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 (Contact Author)

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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