Age-dependent Taxes Research Articles

Flexible Retirement and Optimal Taxation

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 US Social Security. Nevertheless, an optimal combination of age-dependent linear taxes with increasing-in-age retirement benefits generates welfare gains close to optimal.

The effect of endogenous human capital accumulation on optimal taxation

This paper considers the impact of learning-by-doing on optimal tax policy in a general equilibrium heterogeneous agent life-cycle model. Analytically, it identifies two main channels by which learning-by-doing alters the optimal tax policy. First, learning-by-doing creates a motive for the government to use age-dependent labor income taxes. If the government cannot condition taxes on age, then a capital tax or progressive/regressive labor income tax can be used in order to mimic age-dependent taxes. Second, a progressive/regressive labor income tax is potentially more distortionary in a model with learning-by-doing since the distortion is propagated through the additional intertemporal link between current labor and future human capital. Quantitatively, I find that both of these channels are important for the optimal tax policy. Adding learning-by-doing leads to a notably flatter optimal labor income tax due to the second channel. Moreover, including learning-by-doing causes an increase in the optimal capital tax due to the first channel. I find that when solving for the optimal tax policy in the learning-by-doing model, the welfare consequences of not accounting for endogenous human capital accumulation are equivalent to around one percent of expected lifetime consumption, a majority of which are due to adopting too progressive of a tax policy.

The Effect of Endogenous Human Capital Accumulation on Optimal Taxation

This paper considers the impact of learning-by-doing on optimal tax policy in a general equilibrium heterogenous agent life-cycle model. Analytically, it identifies two main channels by which learning-bydoing alters the optimal tax policy. First, learning-by-doing creates a motive for the government to use age-dependent labor income taxes. If the government cannot condition taxes on age, then a capital tax or progressive/regressive labor income tax can be used in order to mimic age-dependent taxes. Second, a progressive/regressive labor income tax is potentially more distortionary in a model with learning-bydoing since the distortion is propagated through the additional intertemporal link between current labor and future human capital. Quantitatively, I find that both of these channels are important for the optimal tax policy. Adding learning-by-doing leads to a notably flatter optimal labor income tax due to the second channel. Moreover, including learning-by-doing causes an increase in the optimal capital tax due to the first channel. I find that when solving for the optimal tax policy in the learning-by-doing model, the welfare consequences of not accounting for endogenous human capital accumulation are equivalent to around one percent of expected lifetime consumption, a majority of which are due to adopting too progressive of a tax policy.

Optimal tax and expenditure policy in the presence of emigration

Purpose – This paper aims to present a theoretical underpinning for the fact that empirical studies have found an inverted-U curve relationship between emigration and per capita income, based on credit restrictions. The implications for tax policy are also analyzed. Design/methodology/approach – Using an intertemporal general equilibrium model, the authors characterize how the presence of an “inverted U-curve” relationship between emigration and per capita income will influence the optimal tax and expenditure policy in a country where agents have the option to move abroad. Findings – Among the results it is shown that if age-dependent taxes are available, the presence of an inverted-U curve provides an incentive to tax young labor harder, but old labor less hard, than otherwise. Originality/value – This migration model fits the empirical facts of migration better than most of the migration models previously used in the optimal taxation literature.

Insurance and Taxation over the Life Cycle

We consider a dynamic Mirrlees economy in a life-cycle context and study the optimal insurance arrangement. Individual productivity evolves as a Markov process and is private information. We use a first-order approach in discrete and continuous time and obtain novel theoretical and numerical results. Our main contribution is a formula describing the dynamics for the labour-income tax rate. When productivity is an AR(1) our formula resembles an AR(1) with a trend where: (i) the auto-regressive coefficient equals that of productivity; (ii) the trend term equals the covariance productivity with consumption growth divided by the Frisch elasticity of labour; and (iii) the innovations in the tax rate are the negative of consumption growth. The last property implies a form of short-run regressivity. Our simulations illustrate these results and deliver some novel insights. The average labour tax rises from 0% to 37% over 40 years, whereas the average tax on savings falls from 12% to 0% at retirement. We compare the second best solution to simple history-independent tax systems, calibrated to mimic these average tax rates. We find that age-dependent taxes capture a sizable fraction of the welfare gains. In this way, our theoretical results provide insights into simple tax systems.

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

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.

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

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.

On the optimality of age-dependent taxes and the progressive U.S. tax system

In life-cycle economies, where an individual's optimal consumption-work plan is almost never constant, the optimal marginal tax rates on capital and labor income vary with age. Conversely, the progressivity imbedded in the U.S. tax code implies that marginal tax rates vary with age because tax rates vary with earnings and earnings vary with age. Using numerical simulations, this paper shows that if the tax authority is prevented from conditioning tax rates on age, some degree of progressivity is desirable as progressive taxation better imitates optimal age-dependent taxes than an optimal age-independent tax system. This role for progressive taxation emanates from efficiency reasons and does not rely on any insurance nor re-distribution arguments.

The Surprising Power of Age-Dependent Taxes

This paper provides a new, empirically driven application of the dynamic Mirrleesian framework by studying a feasible and potentially powerful tax reform: age-dependent labour income taxation. I show analytically how age dependence improves policy on both the intratemporal and intertemporal margins. I use detailed numerical simulations, calibrated with data from the U.S. Panel Study of Income Dynamics, to generate robust policy implications: age dependence (1) lowers marginal taxes on average and especially on high-income young workers and (2) lowers average taxes on all young workers relative to older workers when private saving and borrowing are restricted. Finally, I calculate and characterize the welfare gains from age dependence. Despite its simplicity, age dependence generates a welfare gain equal to between 0·6% and 1·5% of aggregate annual consumption, and it captures more than 60% of the gain from reform to the dynamic optimal policy. The gains are due to substantial increases in both efficiency and equity. When age dependence is restricted to be Pareto improving, the welfare gain is nearly as large.

The Base for Direct Taxation

The traditional starting place for a study of tax reform is a definition of an ideal tax base, which is then adjusted in light of additional issues. After arguing briefly that this is not a good starting place, the essay reviews the optimal taxation literature inferences for tax base policy, focusing on three questions. - If there is annual non-linear (progressive) taxation of earnings, how should annual capital income be taxed - not at all, linearly (flat rate, as in the Nordic dual income tax), by relating the marginal tax rates on capital and labour incomes (as in the US), or by taxing all income the same? - If there is annual non-linear taxation of earnings, should there be a deduction for net savings? - If there is annual non-linear taxation of earnings, is it worth having a more complex tax structure, particularly age-dependent tax rates? Would greater use of age-dependent rules in capital income taxation be worthwhile? The essay presents the Atkinson-Stiglitz and Chamley-Judd results that capital income should not be taxed, but concludes that the required conditions are too restrictive and not robust enough for policy purposes. Hence there should be some role for including capital income as a part of the tax base. The essay discusses some empirical underpinnings for two key elements in the conclusion - differences in savings propensities and the shape of earnings (and uncertainty about earnings) over the lifetime. The conclusion that capital income should be taxed does not lead to the conclusion that the tax base should be total income, the sum of labour income and capital income. The chapter leans toward relating marginal tax rates on capital and labour incomes as opposed to the Nordic dual tax. Also examined are age-dependent taxes (for example different taxation of earnings for workers of different ages).

To draft or not to draft? Inefficiency, generational incidence, and political economy of military conscription

We study the military draft as a form of intergenerational redistribution, taking into account endogenous human capital formation. Introducing the military draft initially benefits the older generation while it harms the young and all future generations. As it distorts human capital formation more severely than an equivalent intergenerational transfer using public debt or pay-as-you-go pensions, the draft can be abolished in a Pareto-improving way if age-dependent taxes are available. In the absence of age-specific taxes, the political allure of the draft can be explained by the specific intergenerational incidence of its costs and benefits.

To Draft or Not to Draft? Efficiency, Generational Incidence, and Political Economy of Military Conscription

We study the efficiency and distributional consequences of establishing and abolishing the draft in a dynamic model with overlapping generations, taking into account endogenous human capital formation as well as government budget constraints. The introduction of the draft initially benefits the older generation while harming the young and all future generations. Its Pareto-improving abolition requires levying age-dependent taxes on the young. These being infeasible, abolition of the draft would harm the old. The intergenerational incidence of the gains and losses from its introduction and abolition helps to explain the political allure of the draft.