Progressive Pension and Optimal Tax Progressivity

Abstract

We examine how progressivity in the income tax and public pension systems can complement one another in achieving redistribution and efficiency. Our analysis shows that shifting redistributive and social insurance roles from the tax system to a more progressive, means-tested pension scheme can enhance overall welfare. In particular, reducing tax progressivity—by flattening the income tax schedule—while increasing pension progressivity through stricter means-testing delivers significant welfare gains. The optimal policy design features a proportional income tax paired with a tightly means-tested pension system. These findings suggest that redistributive objectives are more effectively achieved through targeted transfers, while lowering tax progressivity is crucial for improving aggregate efficiency.

Keywords: Heterogeneity, Progressive taxes, Age pension, Welfare, Administrative data, Dynamic general equilibrium.