Staff Report 551

Optimal Progressivity with Age-Dependent Taxation

Jonathan Heathcote | Monetary Advisor
Kjetil Storesletten
Giovanni L. Violante

Revised February 25, 2019

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.

DOI: https://doi.org/10.21034/sr.551


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