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

Abstract

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.

Some information and suggestions:

• Please register for the seminar here. You will then receive the details of the zoom session by email.

• Please keep your microphone on mute, except when asking a question.

• Asking questions: please just go ahead and ask questions in the “usual way” (ie, don’t use the chat for this; but please do use it to notify the host of any problem related to seminar).

• Please use the registration form also to register for a Zoom bilateral. Deadline is Thursday 11 March at 9:00.