Abstract
Is the Spanish economy positioned at its optimal progressivity level in personal income tax? This article quantifies the aggregate, distributional, and welfare consequences of moving toward such an optimal level. A heterogeneous households general equilibrium model featuring both life cycle and dynastic elements is calibrated to replicate some characteristics of the Spanish economy and used to evaluate potential reforms of the tax system. The findings suggest that increasing progressivity would be optimal, even though it would involve an efficiency loss. The optimal reform of the tax schedule would reduce wealth and income inequality at the cost of negative effects on capital, labor, and output. Finally, these theoretical results are evaluated using tax microdata and describe a current scenario where the income-top households typically face suboptimal effective average tax rates.
Highlights
Which economy with level of progressivity from τ = 0.00 to τ = 0.50 results in a steady state with higher aggregate welfare?19 Are these aggregate welfare changes mainly driven by the change in the tax scheme? Or do they principally arise from induced shifts in the distribution of households or in the prices of the economy? How are these welfare changes distributed across households? A Benthamite social welfare function is used to answer these sort of concerns
The consumption of the average household of the model economy would need to be increased by 3.08% in every period and in every state for the social planner to be indifferent between the steady-state allocation implied by the actual progressivity level and the steady-state allocation that results from establishing a progressivity level of τ = 0.23 and increasing the average level of taxes up to λ = 1.18.20 it can be deduced that implementing levels of progressiv
A heterogeneous households general equilibrium model featuring both life cycle and dynastic elements is calibrated to replicate some relevant characteristics of the Spanish economy and used to evaluate potential reforms of the income tax system
Summary
Many modern governments implement a redistributive fiscal policy, where personal income is taxed at an increasingly higher rate, while transfers tend to target the poorest. The most efficient working households and the wealthiest ones (either working or non-working) are those who experience the largest trade-off between (i) positive welfare effects derived from higher income (due to an increased interest rate that pushes up capital returns) and (ii) adverse effects emerging from higher tax payments (due to the increase in progressivity of the income (i) are devoted to account for income and wealth inequality and (ii) study decisions of households that Footnote 3 continued face labor income processes that are random, household-specific, and uninsurable In these model-based economies, households accumulate wealth in part to smooth their consumption.
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