Redistributing the Gains from Trade Through Progressive Taxation

47 Pages Posted: 13 Jul 2018 Last revised: 29 Jun 2022

See all articles by Spencer Lyon

Spencer Lyon

New York University (NYU) - Leonard N. Stern School of Business

Michael E. Waugh

New York University (NYU), Leonard N. Stern School of Business, Department of Economics

Date Written: June 2018

Abstract

Should a nation's tax system become more progressive as it opens to trade? Does opening to trade change the benefits of a progressive tax system? We answer these question within a standard incomplete markets model with frictional labor markets and Ricardian trade. Consistent with empirical evidence, adverse shocks to comparative advantage lead to labor income losses for import-competition-exposed workers; with incomplete markets, these workers are imperfectly insured and experience welfare losses. A progressive tax system is valuable, as it substitutes for imperfect insurance and redistributes the gains from trade. However, it also reduces the incentives for labor to reallocate away from comparatively disadvantaged locations. We find that optimal progressivity should increase with openness to trade with a ten percentage point increase in openness necessitating a five percentage point increase in marginal tax rates for those at the top of the income distribution.

Suggested Citation

Lyon, Spencer and Waugh, Michael E., Redistributing the Gains from Trade Through Progressive Taxation (June 2018). NBER Working Paper No. w24784, Available at SSRN: https://ssrn.com/abstract=3210438

Spencer Lyon (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

Suite 9-160
New York, NY
United States

Michael E. Waugh

New York University (NYU), Leonard N. Stern School of Business, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

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