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Optimal Progressivity with Age-Dependent Taxation

Staff Report 551 | Published February 25, 2019

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Authors

Jonathan Heathcote Monetary Advisor
Kjetil Storesletten University of Oslo and CEPR
Giovanni L. Violante Princeton University, CEBI, CEPR, IFS, IZA, and NBER
Optimal Progressivity with Age-Dependent Taxation

Abstract

This paper studies optimal taxation of earnings when the degree of tax progressivity is allowed to vary with age. The setting is an overlapping-generations model that incorporates irreversible skill investment, flexible labor supply, ex-ante heterogeneity in the disutility of work and the cost of skill acquisition, partially insurable wage risk, and a life cycle productivity profile. An analytically tractable version of the model without intertemporal trade is used to characterize and quantify the salient trade-offs in tax design. The key results are that progressivity should be U-shaped in age and that the average marginal tax rate should be increasing and concave in age. These findings are confirmed in a version of the model with borrowing and saving that we solve numerically.


Published in _Journal of Public Economics_ (Vol. 189, Sept. 2020, article 104074) https://doi.org/10.1016/j.jpubeco.2019.104074.