Creator: Chen, Daphne, Guvenen, Fatih, Kambourov, Gueorgui, Kuruscu, Burhanettin, and Ocampo, Sergio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 764 Abstract:
How does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent heterogeneity in rates of return across individuals, we revisit this question. With such heterogeneity, the two tax systems have opposite implications for both efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive, and therefore generate more income, pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the US data, replacing the capital income tax with a wealth tax in a revenue-neutral fashion delivers a significantly higher average lifetime utility to a newborn (about 7.5% in consumption-equivalent terms). Turning to optimal taxation, the optimal wealth tax (OWT) in a stationary equilibrium is positive and yields even larger welfare gains. In contrast, the optimal capital income tax (OCIT) is negative—a subsidy—and large, and it delivers lower welfare gains than the wealth tax. Furthermore, the subsidy policy increases consumption inequality, whereas the wealth tax reduces it slightly. We also consider an extension that models the transition path and find that individuals who are alive at the time of the policy change, on average, would incur large welfare losses if the new policy is OCIT but would experience large welfare gains if the new policy is an OWT. We conclude that wealth taxation has the potential to raise productivity while simultaneously reducing consumption inequality.
Keyword: Rate of return heterogeneity, Wealth inequality, Wealth taxation, Capital income tax, and Power law models Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth, E22 - Investment; Capital; Intangible Capital; Capacity, E62 - Fiscal Policy, and H21 - Taxation and Subsidies: Efficiency; Optimal Taxation
Creator: McGrattan, Ellen R., Miyachi, Kazuaki, and Peralta-Alva, Adrian Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 586 Abstract:
Japan is facing the problem of how to finance retirement, health care, and long-term care expenditures as the population ages. This paper analyzes the impact of policy options intended to address this problem by employing a dynamic general equilibrium overlapping generations model, specifically parameterized to match both the macro- and microeconomic level data of Japan. We find that financing the costs of aging through gradual increases in the consumption tax rate delivers better macroeconomic performance and higher welfare for most individuals relative to other financing options, including raising social security contributions, debt financing, and a uniform increase in health care and long-term care copayments.
Keyword: Japan, Retirement, Aging, Taxation, and Health care Subject (JEL): H55 - Social Security and Public Pensions, I13 - Health Insurance, Public and Private, E62 - Fiscal Policy, and H51 - National Government Expenditures and Health
Creator: Heathcote, Jonathan and Tsujiyama, Hitoshi Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 507 Abstract:
What structure of income taxation maximizes the social benefits of redistribution while minimizing the social harm associated with distorting the allocation of labor input? Many authors have advocated scrapping the current tax system, which redistributes primarily via marginal tax rates that rise with income, and replacing it with a flat tax system, in which marginal tax rates are constant and redistribution is achieved via non-means-tested transfers. In this paper we compare alternative tax systems in an environment with distinct roles for public and private insurance. We evaluate alternative policies using a social welfare function designed to capture the taste for redistribution reflected in the current tax system. In our preferred specification, moving to the optimal flat tax policy reduces welfare, whereas moving to the optimal fully nonlinear Mirrlees policy generates only tiny welfare gains. These findings suggest that proposals for dramatic tax reform should be viewed with caution.
Keyword: Mirrlees taxation, Social welfare functions, Private insurance, Ramsey taxation, Tax progressivity, Flat tax, and Optimal income taxation Subject (JEL): H23 - Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies, H21 - Taxation and Subsidies: Efficiency; Optimal Taxation, E62 - Fiscal Policy, and H31 - Fiscal Policies and Behavior of Economic Agents: Household
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 125 Abstract:
This paper presents a simple general equilibrium model of optimal taxation similar to that of Lucas and Stokey (1983), except that we let the government default on its debt. As a benchmark, we consider Ramsey equilibria in which the government can precommit its policies at the beginning of time. We then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational. We concentrate on trigger mechanisms which specify reversion to the finite horizon equilibrium after deviations by the government. The main result is that no Ramsey equilibrium with positive debt can be supported by such trigger mechanisms.
Subject (JEL): E62 - Fiscal Policy and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
Creator: Aiyagari, S. Rao and Peled, Dan Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 197 Abstract:
It is often argued that with a positively skewed income distribution (median less than mean) majority voting would result in higher tax rates than maximizing average welfare and, hence, lower aggregate savings. We reexamine this view in a capital accumulation model, in which distorting redistributive taxes provide insurance against idiosyncratic shocks and income distributions evolve endogenously. We find small differences of either sign between the tax rates set by a majority voting and a utilitarian government, for reasonable parametric specifications, despite the fact that model simulations produce positively skewed distributions of total income across agents.
Keyword: Proportional taxes, Sequential majority voting, and Utilitarian government Subject (JEL): H23 - Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies, C68 - Computable General Equilibrium Models, and E62 - Fiscal Policy
Creator: Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 321 Abstract:
Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans. In this paper, I examine the role of taxes in accounting for the differences in labor supply across time and across countries, in particular, the effective marginal tax rate on labor income. The population of countries considered is that of the G-7 countries, which are major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of the differences at points in time and the large change in relative labor supply over time with the exception of the Italian labor supply in the early 1970s.
Keyword: International Tax Rates, Social Security Reform, and International Labor Supply Subject (JEL): E13 - General Aggregative Models: Neoclassical, E62 - Fiscal Policy, H20 - Taxation, Subsidies, and Revenue: General, and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Creator: Christiano, Lawrence J. and Harrison, Sharon G. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 214 Abstract:
We study a one-sector growth model which is standard except for the presence of an externality in the production function. The set of competitive equilibria is large. It includes constant equilibria, sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. The efficient allocation is characterized by constant employment and a constant growth rate. We identify an income tax-subsidy schedule that supports the efficient allocation as the unique equilibrium outcome. That schedule has two properties: (i) it specifies the tax rate to be an increasing function of aggregate employment, and (ii) earnings are subsidized when aggregate employment is at its efficient level. The first feature eliminates inefficient, fluctuating equilibria, while the second induces agents to internalize the externality.
Keyword: Stabilization, Fiscal policy, Business cycle, Multiple equilibria, and Regime switching Subject (JEL): E13 - General Aggregative Models: Neoclassical, E62 - Fiscal Policy, and E32 - Business Fluctuations; Cycles
Creator: McGrattan, Ellen R. and Schmitz, James Andrew Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 250 Abstract:
This chapter reviews the literature that tries to explain the disparity and variation of GDP per worker and GDP per capita across countries and across time. There are many potential explanations for the different patterns of development across countries, including differences in luck, raw materials, geography, preferences, and economic policies. We focus on differences in economic policies and ask to what extent can differences in policies across countries account for the observed variability in income levels and their growth rates. We review estimates for a wide range of policy variables. In many cases, the magnitude of the estimates is under debate. Estimates found by running cross-sectional growth regressions are sensitive to which variables are included as explanatory variables. Estimates found using quantitative theory depend in critical ways on values of parameters and measures of factor inputs for which there is little consensus. In this chapter, we review the ongoing debates of the literature and the progress that has been made thus far.
Keyword: Growth regressions, Endogenous growth theory, Growth accounting, and Cross-country income differences Subject (JEL): O11 - Macroeconomic Analyses of Economic Development, E65 - Studies of Particular Policy Episodes, E62 - Fiscal Policy, O41 - One, Two, and Multisector Growth Models, and O47 - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 251 Abstract:
We provide an introduction to optimal fiscal and monetary policy using the primal approach to optimal taxation. We use this approach to address how fiscal and monetary policy should be set over the long run and over the business cycle. We find four substantive lessons for policymaking: Capital income taxes should be high initially and then roughly zero; tax rates on labor and consumption should be roughly constant; state-contingent taxes on assets should be used to provide insurance against adverse shocks; and monetary policy should be conducted so as to keep nominal interest rates close to zero. We begin optimal taxation in a static context. We then develop a general framework to analyze optimal fiscal policy. Finally, we analyze optimal monetary policy in three commonly used models of money: a cash-credit economy, a money-in-the-utility-function economy, and a shopping-time economy.
Keyword: Capital income taxation, Ramsey problems, Friedman rule, Tax smoothing, and Primal approach Subject (JEL): E52 - Monetary Policy, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, H30 - Fiscal Policies and Behavior of Economic Agents: General, H21 - Taxation and Subsidies: Efficiency; Optimal Taxation, and E62 - Fiscal Policy
Creator: Krueger, Dirk and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 262 Abstract:
We explore the welfare consequences of different taxation schemes in an economy where agents are debt-constrained. If agents default on their debt, they are banned from future credit markets, but retain their private endowments which are subject to income taxation. A change in the tax system changes the severity of punishment from default and, hence, leads to a limitation of possible risk sharing via private contracts. The welfare consequences of a change in the tax system depend on the relative magnitudes of increased risk sharing forced by the new tax system and the reduced risk sharing in private insurance markets. We quantitatively address this issue by calibrating an artificial economy to US income and tax data. We show that for a plausible selection of the structural parameters of our model, the change to a more redistributive tax system leads to less risk sharing among individuals and lower ex-ante welfare.
Keyword: Risk Sharing, Redistributive Taxation, and Incomplete Markets Subject (JEL): E62 - Fiscal Policy, D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, and H31 - Fiscal Policies and Behavior of Economic Agents: Household