Optimal taxation over the life cycle

Abstract

We derive the optimal labor income tax schedule for a life cycle model with deterministic productivity variation and complete asset markets. An individual chooses whether and how much to work at each date. The government must finance a given expenditure and does not have access to lump sum taxation. We develop a solution method that uses the primal approach to solve for the optimal non-linear tax function. The average tax rate determines when an individual will work while the marginal tax rate determines how much she will work. Even in the absence of redistributive concerns, the optimal tax schedule has an increasing average tax rate at low levels of income to encourage labor market participation. The marginal tax rate at the top is strictly positive. Finally, the model is used to assess the effects of changing the current tax schedule to the optimal one. Under the preferred parameters, this delivers a welfare gain equivalent to 0.67 percent of lifetime consumption.

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About the Author

 

Aspen
Gorry
  • Macroeconomist Aspen Gorry studies employment and tax policy. His research focuses on jobs, specifically on how labor market policies impact employment outcomes for young workers. He has written about the impact of minimum wages on youth unemployment, optimal taxation over a worker's life cycle and the importance of early career experience for workers' labor market outcomes. Before joining AEI, he taught economics at the University of California, Santa Cruz.

  • Phone: 435-797-2397
    Email: aspen.gorry@aei.org
  • Assistant Info

    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

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