Working Paper

Optimal Fiscal Reform with Many Taxes

Abstract: We study the optimal one-shot tax reform in the standard incomplete markets model where households differ in their wealth, earnings, permanent labor skill, and age. The government can provide transfers by raising tax revenue and has several tax instruments at its disposal: a flat capital income tax, a flat consumption tax, and a non-linear labor income tax. The optimal fiscal policy funds a transfer that is nearly 50 percent of GDP through a combination of very high taxes on consumption and capital income. The labor tax schedule has a high average rate but is also moderately progressive. We find an identical outcome when policy is instead determined by majority voting. Finally, we offer suggestive empirical evidence that households’ preferences for tax and redistribution are more strongly associated with political identity than economic status.

Keywords: Optimal Taxation; Inequality; Heterogeneous Agents; Incomplete Markets; Voting;

JEL Classification: E62; E21; D72; H21;

https://doi.org/10.26509/frbc-wp-202307

Bibliographic Information

Provider: Federal Reserve Bank of Cleveland

Part of Series: Working Papers

Publication Date: 2023-02-09

Number: 23-07

Related Works

• Working Paper Revision (2024-08-28) : Optimal Fiscal Reform with Many Taxes
• Working Paper Original (2023-02-09) : You are here.