Aggregate and Distributional Consequences of Top Income and Wealth Taxes

Paper Session

Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM

Hyatt Regency Chicago, Toronto
Hosted By: American Economic Association
  • Chair: Markus Poschke, McGill University

High Marginal Tax Rates on the Top 1%? Lessons From a Life Cycle Model With Idiosyncratic Income Risk

Fabian Kindermann
,
University of Bonn
Dirk Krueger
,
University of Pennsylvania

Abstract

This paper argues that high marginal labor income tax rates are an effective tool for social insurance even when households have high labor supply elasticity, make dynamic savings decisions, and policies have general equilibrium effects. We construct a large scale Overlapping Generations Model with uninsurable labor productivity risk, show that it has a realistic wealth distribution and then numerically characterize the optimal top marginal rate. We find that marginal tax rates for top 1% earners of close to 90% are optimal as long as the earnings and wealth distributions display a degree of concentration as observed in US data.

The Sufficient Statistic Approach: Predicting the Top of the Laffer Curve

Alejandro Badel
,
Federal Reserve Bank of St. Louis
Mark Huggett
,
Georgetown University

Abstract

We provide a formula for the tax rate at the top of the Laffer curve as a function of three
elasticities. Our formula applies to static models and to steady states of dynamic models and
is relevant for the top tax rate on any component of income. We show how to apply it to many
classic models. We also illustrate the application of the formula using a quantitative human
capital model.

The Macroeconomic and Distributional Effects of Progressive Wealth Taxes

Baris Kaymak
,
University of Montreal
Markus Poschke
,
McGill University

Abstract

The recent rise in wealth inequality has triggered a debate on whether policy measures could and should be taken against it. One widely discussed policy, proposed by Thomas Piketty in his book “Capital in the 20th Century”, is a progressive tax schedule on wealth. In this paper we evaluate the macroeconomic and distributional consequences of this policy. We find that progressive wealth taxes produce substantial revenue, on the order of that currently raised by the corporate income tax. They also lead to a large reduction in top wealth shares. A comparison of steady states suggests that progressive wealth taxes improve average welfare despite their negative effect on capital accumulation and wages. The interaction with other taxes and differential changes in saving incentives across the wealth distribution are key for this result. In particular, general equilibrium effects imply not only reduced top wealth, but also increased asset accumulation by the bottom 80% of the wealth distribution. The latter is key for higher steady state welfare, but also implies welfare losses along the transition to the new steady state. As a consequence, progressive welfare taxes look less attractive if positive welfare weight is placed on current generations.

Higher Taxes at the Top: The Role of Entrepreneurs

Bettina Brüggemann
,
McMaster University

Abstract

This paper contributes to the recent and growing literature on optimal top marginal income tax rates. It computes optimal marginal tax rates for top earners in a Bewley-Aiyagari type economy explicitly accounting for entrepreneurs. Entrepreneurs make up more than one third of the highest-earning one percent in the income distribution despite representing less than ten percent of the population. They are thus disproportionately affected by an increase in the top marginal income tax rate. Since entrepreneurs overall also employ half of the private-sector workforce, such policy changes can have important repercussions for aggregate labor demand and productivity. In the model households face an occupational choice between working for the market wage or starting their own business. Borrowing constraints induce entrepreneurs to save in order to grow. Consistent with the data, entrepreneurs significantly influence aggregate productivity, generate 50 percent of total output, and account for 40 percent of taxpayers in the top tax bracket. Nonetheless, the welfare maximizing top marginal tax rate amounts to 82.5 percent, and the revenue maximizing one to 90 percent. A steady state comparison between the benchmark economy featuring the current US tax system and the economy with the welfare maximizing top marginal tax rate illustrates the underlying mechanisms. The substantial increase in taxes leads to a large degree of redistribution, yielding sizable welfare gains for low-income working and entrepreneurial households. The welfare gains decline with income for workers, as middle-income workers are hurt by lower equilibrium wages. These lower wages however benefit medium-sized entrepreneurs and enable them to grow, such that all entrepreneurs except those directly affected by the higher tax experience considerable welfare gains, and the size of the entrepreneurial sector grows.
Discussant(s)
Dirk Krueger
,
University of Pennsylvania
Baris Kaymak
,
University of Montreal
Alejandro Badel
,
Federal Reserve Bank of St. Louis
Bettina Brüggemann
,
McMaster University
JEL Classifications
  • E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
  • H2 - Taxation, Subsidies, and Revenue