Progressive taxation and income inequality in dynamic competitive equilibrium

Abstract

This paper establishes the existence of a non-degenerate distribution of income in a simple dynamic economy when agents, who are heterogeneous in their rates of impatience, face a progressive tax system. In this dynamic setting, income inequality can vary positively with the degree of tax progressivity. Moreover, the inherent heterogeneity in agents' behavior can explain why measures of inequality, such as the standard deviation of income or Atkinson's Gini, tend to be dynamically much more sluggish than aggregate measures such as total income. Finally, the adjustment in the degree of inequality resulting from an exogenous change in tax policy may take some time before becoming effective. This result also arises from agents' asymmetric responses to policy changes.