How Should Tax Progressivity Respond to Rising Income Inequality?

Jonathan Heathcote, Kjetil Storesletten, Giovanni L. Violante

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

We address the question in the title in a heterogeneous-agent incomplete-market model featuring exogenous idiosyncratic risk, endogenous skill investment, and flexible labor supply. The tax and transfer schedule is restricted to being log-linear in income, a good description of the US system. Rising inequality is modeled as a combination of skill-biased technical change and growth in residual wage dispersion. When facing shifts in the income distribution like those observed in the United States, a utilitarian planner chooses higher progressivity in response to larger residual inequality but lower progressivity in response to widening skill price dispersion reflecting technical change. Overall, optimal progressivity is approximately unchanged between 1980 and 2016. We document that the progressivity of the actual US tax and transfer system has similarly changed little since 1980, in line with the model prescription.

Original languageEnglish (US)
Pages (from-to)2715-2754
Number of pages40
JournalJournal of the European Economic Association
Volume18
Issue number6
DOIs
StatePublished - Dec 1 2020

All Science Journal Classification (ASJC) codes

  • Economics, Econometrics and Finance(all)

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