Optimal Progressive Income Taxation in a Bewley-Grossman Framework

Towson University Department of Economics, Working Paper No. 2017-01

46 Pages Posted: 27 Mar 2017

See all articles by Juergen Jung

Juergen Jung

Towson University - Department of Economics

Chung Tran

Australian National University (ANU) - School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 24, 2017

Abstract

We study the optimal progressivity of income taxation in a Bewley-Grossman model of health capital accumulation where individuals are exposed to earnings and health risks over the lifecycle. We impose the U.S. tax and transfer system and calibrate the model to match U.S. data. We then optimize the progressivity of the income tax code. The optimal income tax system is more progressive than current U.S. income taxes with zero taxes at the lower end of the income distribution and a marginal tax rate of over 50 percent for income earners above US$200,000. The Suits index — a Gini coefficient for the income tax contribution by income — is around 0:53 and much higher than 0:17 in the U.S. benchmark tax system. Welfare gains from switching to the optimal tax system amount to over 5 percent of compensating consumption. Moreover, we find that the structure of the health insurance system affects the degree of optimal progressivity of the income tax system.

The introduction of Affordable Care Act in 2010 — a program that redistributes wealth from high income and healthy types, to low income and sicker types — reduces the optimal progressivity level of the income tax system. Finally, we demonstrate that the optimal tax system is sensitive to the parametric specification of the income tax function and the transfer policy.

Keywords: Health risk, Inequality, Tax progressivity, Suits index, Social insurance, Optimal tax, General equilibrium

JEL Classification: E62, H24, I13, D52

Suggested Citation

Jung, Juergen and Tran, Chung, Optimal Progressive Income Taxation in a Bewley-Grossman Framework (March 24, 2017). Towson University Department of Economics, Working Paper No. 2017-01, Available at SSRN: https://ssrn.com/abstract=2940463 or http://dx.doi.org/10.2139/ssrn.2940463

Juergen Jung (Contact Author)

Towson University - Department of Economics ( email )

Baltimore, MD
United States
812-345-9182 (Phone)

HOME PAGE: http://https://juejung.github.io/

Chung Tran

Australian National University (ANU) - School of Economics ( email )

Arndt Building 25B
Canberra, Australian Capital Territory 0200
Australia

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