Optimal Taxation in Life-Cycle Economies (original) (raw)

2011

This paper considers the impact of endogenous human capital accumulation on optimal tax policy in a life cycle model. Analytically, it demonstrates that including endogenous human capital accumulation, through either learning-by-doing or learning-or-doing, creates a motive for the government to use age-dependent labor income taxes. If the government cannot condition taxes on age, then it is optimal to use a tax on capital in order to mimic age-dependent taxes on labor income. Quantitatively, this work finds that introducing learning-by-doing or learning-or-doing increases the optimal tax on capital by eighty or twenty percent, respectively. Including learning-by-doing leads younger agents to supply labor relatively less elastically than older agents. Given that taxing capital implicitly taxes younger labor income at a higher rate, the optimal tax on capital is larger in this framework. In the case of learning-or-doing, the government increases the tax on capital to encourage individuals to save in the form of human capital as opposed to physical capital.

On Income and Capital Taxation in a Life Cycle Model with Extensive Labor Supply

2009

The paper studies redistributive taxation in a stationary life cycle model with extensive labor supply. Two forms of taxation are investigated in some depth: nonlinear income taxation and linear capital taxation. The optimal income taxation programs of the life cycle and of the static model have similar properties. The life cycle model differs in that the social weights of the dynasties depend on their permanent incomes, not on the observed taxable current income, which is an imperfect signal of the variable of interest. A tax on saving therefore appears as a potentially useful complement to the income tax. The formula for the derivative of social welfare with respect to the tax rate is derived when financial markets are perfect. This derivative, evaluated at the point of zero capital tax, is equal to the opposite of the correlation between the social weight of the dynasties and their aggregate life time savings. When high permanent incomes induce high savings, a tax on capital may have redistributive value, as illustrated on a simple example. JEL classification numbers: H21, H31.

An Extensive Look at Taxes: How Does Endogenous Retirement Affect Optimal Taxation?

SSRN Electronic Journal, 2012

This paper considers the impact on optimal tax policy of including endogenously determined retirement in a life cycle model. Allowing individuals to determine when they retire causes the optimal tax on capital to increase by 75% because of two implicit changes in the aggregate labor supply elasticity. First, including endogenous retirement causes an increase in the overall aggregate labor supply elasticity since agents can change their labor supply on both the intensive and extensive margins. In response, the government limits the distortions from the tax policy by lowering the tax on labor and increases the tax on capital. Second, given that the choice to retire is more relevant for older individuals, endogenous retirement disproportionately increases older agent's elasticity compared to younger individuals. Ideally, the government would decrease the relative labor income tax on individuals when they are older and supply labor more elastically. However, in the absence of age-dependent taxes, the government mimics such a tax policy by further increasing the tax on capital. I find that the welfare lost from not accounting for endogenous retirement when solving for the optimal tax policy is equivalent to approximately one percent of lifetime consumption.

The Effect of Endogenous Human Capital Accumulation on Optimal Taxation

SSRN Electronic Journal, 2012

This paper considers the impact of endogenous human capital accumulation on optimal tax policy in a life cycle model. Including endogenous human capital accumulation, either through learning-by-doing or learning-or-doing, is analytically shown to create a motive for the government to use age-dependent labor income taxes. If the government cannot condition taxes on age, then it is optimal to use a tax on capital in order to mimic such taxes. Quantitatively, introducing learning-by-doing or learning-ordoing increases the optimal tax on capital by forty or four percent, respectively. Overall, the optimal tax on capital is thirty five percent higher in the model with learning-by-doing compared to the model with learning-or-doing implying that how human capital accumulates is of significant importance when determining the optimal tax policy.

On Income and Wealth Taxation in A Life-Cycle Model with Extensive Labour Supply*

The Economic Journal, 2011

In a stationary life-cycle model with extensive labour supply, two forms of taxation are studied: nonlinear income taxation and linear wealth taxation. In the life-cycle model, the social weights of the dynasties depend on their permanent incomes, not on the observed taxable current income. A tax on wealth then can complement income tax as a redistributive tool. The derivative of social welfare with respect to the wealth tax rate at the no-tax point is computed. It is positive whenever permanent income is positively correlated with aggregate life time savings. This result is illustrated on a numerical example.

Optimal Taxation and Social Insurance in a Lifetime Perspective

SSRN Electronic Journal, 2006

Advances in information technology have improved the administrative feasibility of redistribution based on lifetime earnings recorded at the time of retirement. We study optimal lifetime income taxation and social insurance in an economy in which redistributive taxation and social insurance serve to insure (ex ante) against skill heterogeneity as well as disability risk. Optimal disability benefits rise with previous earnings so that public transfers depend not only on current earnings but also on earnings in the past. Hence, lifetime taxation rather than annual taxation is optimal. The optimal tax-transfer system does not provide full disability insurance. By offering imperfect insurance and structuring disability benefits so as to enable workers to insure against disability by working harder, social insurance is designed to offset the distortionary impact of the redistributive labor income tax on labor supply.

Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives

Econometrica, 1986

This paper analyzes the optimal tax on capital income in general equilibrium models of the second best. Agents have infinite lives and utility functions which are extensions from the Koopmans form. The population is heterogeneous. The important property of the models is the equality between the social and the private discount rates in the long run. I find that the optimal tax rate is zero in the long run. For a special case of additively separable utility functions, I then determine the tax rates along the dynamic path and conditions that are sufficient for the local stability of the steady state. ' Discussions with Paul Champsaur, Dale Jorgenson, Laurence Kotlikoff, and participants of seminars at C.O.R.E. and at Yale have been stimulating. Comments by the editor and by an anonymous referee were particularly helpful. Partial financial support from a C.O.R.E. fellowship is gratefully acknowledged. Donna Zerwitz provided expert editorial assistance. * Pestieau [13] has shown that under some conditions, the standard Ramsey tax formulae (Diamond and Mirrlees [a]), apply in the steady state of a general equilibrium model with overlapping generations. For a discussion of some of these conditions, see Atkinson and Sandmo [3]. Summers [14] has remarked that in life-cycle models with additively separable utility functions and constant pure rate of time preference, the long-run interest elasticity of supply for savings increases with the number of periods. This would imply that the interest tax has a large welfare cost, and that its rate in the second best is relatively low. His analysis is restricted to a comparison between steady states. The framework of this paper does not make these restrictive assumptions about the utility function, and the second best policy optimizes over the entire dynamic path.

Optimal Tax Policy in a Stochastically Growing Economy

The Japanese Economic Review, 1995

This paper analyses the optimal taxation of capital in a stochastically growing small open economy in which there is a perfect market for a traded bond. The analysis emphasizes the dependence of the optimal tax structure upon the policy rule guiding the growth of government expenditure, and its impact on the behaviour of private agents. In general three taxes, reflecting three required conditions, are necessary to attain the first-best optimum. The first is to correct for any externality caused by government expenditure; the second is to attain the optimal portfolio share; the third is to ensure that the government budget constraint is met. * A previous version of this paper was presented at the University of British Columbia. Comments made by seminar participants and by Seren Nielsen are gratefully acknowledged.-125-0 Japan Association of Economics and Econometrics 1995. Published by Blackwell Publishers, 108 Cowley Road. Oxford OX4 IJF. UK. 1) Sen and Turnovsky employ the conventional infinite-lived representative agent model, while Nielsen and S0rensen adopt the infinitely-lived overlapping families model. 2) Some discussion of optimal taxation of capital within the intertemporal optimizing framework is presented by Frenkel, Razin and Sadka (1991, chapter 5). However, their analysis is restricted to only two periods.-126-I 0 Japan Association of Economics and Econometrics 1995.

Tax‐Deductible Saving in a Life Cycle Growth Model*

Australian Economic Papers, 1992

I. INTRODUCTION Among the most interesting debates in the public finance literature during the past few years has been that over the effect of income taxes on saving behaviour, and the extent of the long-run welfare gains that could be obtained by switching from an income tax to a consumption tax. The issue has also engendered interest among tax practitioners with major reports supporting the principle of consumption taxation having been prepared by the United States Tteasury (1977), by the Institute for Fiscal Studies (1978) in the United Kingdom and by the Economic Council of Canada (1987) (hereafter referred to as Blueprints, the Meade committee report and the ECC report, respectively). Not surprisingly, the literature on the subject reveals that the magnitude of the efficiency and welfare gains from moving to a consumption tax varies, depending on the model used and the nature of the underlying assumptions. For example, Summers (1981) used a simple dynamic model consisting of a single production sector producing a homogenous commodity that can be used for consumption or for capital formation, and a single representative individual in each age group. According to Summers, with an intertemporal elasticity of substitution between consumption in different periods (u) of unity and a Cobb-Douglas production function, a shift from a proportional income tax to a proportional consumption tax would raise the capitalAabour ratio in the economy from 3.17 to 6.60, and yield a 16 per cent increase in steady state consumption per capita, which would raise welfare by about 12 per cent. In a similar experiment, Auerbach, Kotlikoff and Skinner (1983) found that with u = 0.25, a consumption tax would increase the capitalAabour ratio from 3.04 to 4.38 and lead to a steady state welfare gain of more than six per cent. Since the most relevant choice is between progressive rather than proportional taxes, Auerbach er al. also simulated the effects of a switch from a progressive income tax to a progressive consumption tax and found that it would result in a welfare gain of five per cent. In contrast to the relatively simple models used by Summers and Auerbach et al., Fullerton, Shoven and Whalley (1983) used a dynamic general equilibrium ' The authors are indebted to Professor Mike Burns and two anonymous referees for their suggestions. The usual disclaimer applies. The views expressed herein are those of the authors and do not necessarily reflect those of any organisation with which the authors have been associated. 399 DECEMBER 400 AUSTRALIAN ECONOMIC PAPERS model consisting of 19 industrial sectors, a single capital good and 12 groups of consumers differentiated by income class, for which both average and marginal tax rates increase with income. The simulation by Fullerton et al. comparable with the experiment performed by Summers and Auerbach et al. produced an aggregate welfare gain of roughly three per cent! Curiously, the foregoing studies, as well as most other attempts to determine the dynamic efficiency and welfare gains from switching to a consumption tax, have not paid sufficient attention to two key features of the consumption tax systems proposed in the reports by the US 'Tteasury, the Meade committee and the ECC. First, whereas these reports favoured a progressive consumption tax such that individuals face rising marginal tax rates, only Auerbach et al. and more recently Auerbach and Kotlikoff (1987), incorporate increasing marginal tax rates when considering the effects of a switch from an income tax to a consumption tax? Second, and more importantly, under the graduated consumption tax systems proposed by Blueprints, the ECC and, to a lesser extent, the Meade committee, individuals would have significant latitude in determining the amounts that they save in registered (tax-deductible) or unregistered (non-tax-deductible) forms! Of the studies referred to above, only Fullerton et al. consider registered and unregistered saving: their analysis, however, did not adequately specify the optimal allocation of saving between the two forms?

Flexible Retirement and Optimal Taxation

2018

This paper studies optimal insurance against private idiosyncratic shocks in a life-cycle model with intensive labor supply and endogenous retirement. In this environment, the optimal labor tax is hump-shaped in age: insurance benefits of taxation push for increasing-in-age taxes while rising labor supply elasticities and optimal late retirement of highly productive workers push for lowering taxes for old workers. In calibrated numerical simulations, the optimum achieves sizable welfare gains that age-dependent taxes do not deliver under the status quo U.S. Social Security. Nevertheless, an optimal combination of age-dependent linear taxes with increasing-in-age retirement benefits generates welfare gains close to optimal.

Optimal Taxation in Life-Cycle Economies (original) (raw)

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