Taxation of Durables, Non-Durables and Earnings with Heterogeneous Preferences

Abstract

In this paper, I adopt a dynamic structural approach to study the design of consumption and personal income taxes and their interactions. I develop a life-cycle model of household consumption, saving and employment choices with multiple non-durable goods - necessities and luxuries - and partially irreversible durables. I estimate the model on micro data and use it to quantitatively characterize the optimal tax rates on different commodities and on labor income in a utilitarian framework and under alternative scenarios of preference heterogeneity. I find that durables should be subsidized in presence of pre-commitment and uncertainty and that the optimal combination of taxes on non-durables and income crucially depends on the degree of preference heterogeneity. Allowing for government inequality aversion, I show that the model can rationalize the tax systems observed in reality and that differentiated consumption taxes serve a redistributive purpose jointly with the progressivity of labor income taxes.