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Larger Transfers Financed with More Progressive Taxes? On the Optimal Design of Taxes and Transfers

  • Series
  • Speaker(s)
    Axelle Ferriere (Paris School of Economics, France)
  • Field
  • Location
  • Date and time

    March 15, 2021
    12:00 - 13:00


The U.S. fiscal system redistributes through a rich set of taxes and transfers, the latter accounting for a large part of the income perceived by the poorest households. Motivated by this, we study the optimal joint design of transfers and income taxes. Within a simple heterogeneous-household framework, we derive two analytical results. First, higher transfers reduce the optimal income tax progressivity. Second, optimal transfers are positive. Redistribution is achieved with generous transfers while efficiency is preserved via a lower progressivity of income taxes. As such, the optimal tax-and-transfer system features larger progressivity of average than of marginal tax rates. We then quantify the optimal tax-and-transfer system in a richer incomplete-market model with realistic wealth distribution and unemployment risk. The model features a novel flexible functional form for progressive income taxes and means-tested transfers. Relative to the current U.S. fiscal system, the optimal policy consists of more generous means-tested transfers, which phase-out at a slower rate, together with less progressive income taxes.

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