Research

Publications

Income tax in the U.S. has become less progressive since the late 1970s in spite of rising income inequality. Why? Modeling policy makers as a Ramsey government that may weight heterogeneous households differently, I find that economic changes can explain about 61% of the reduction in progressivity observed. Aging population and declining gender gap induce a less progressive income tax, whereas changing idiosyncratic risks and the declines of labor share and interest rate have the opposite effects. Rising skill premium is about neutral in this regard. The remaining reduction in progressivity implies a shift in the government’s weights towards high-ability households. From a utilitarian point of view, the income tax change since the late 1970s induces a welfare gain equivalent to 2.12% of lifetime consumption.


We show that a calibrated life cycle two-earner household model with endogenous labor supply can rationalize the extent of consumption insurance against shocks to male and female wages, as estimated empirically by Blundell, Pistaferri, and Saporta-Eksten (2016) in US data. In the model, 35 percent of male and 18 percent of female permanent wage shocks pass through to consumption, compared to the empirical estimates of 32 percent and 19 percent. Most of the consumption insurance against permanent male wage shocks is provided through the presence and labor supply response of the female earner. Abstracting from this private intrahousehold income insurance mechanism strongly biases upward the welfare losses from idiosyncratic wage risk as well as the desired extent of public insurance through progressive income taxation. Relative to the standard one-earner life cycle model, the optimal degree of tax progressivity is significantly lower and the welfare gains from implementing the optimal system are cut roughly in half.

Working Papers

Household welfare is better associated with lifetime income, yet most countries' progressive income taxes focus on current-year income for reducing inequality. Is lifetime income a better tax base for income redistribution? To answer this question, we build a quantitative life-cycle model of heterogeneous households with endogenous labor supply and idiosyncratic wage risks, and calibrate it to the U.S. economy. We find that the welfare potential of tax reform within the annual tax system is rather limited, but a lifetime income tax can deliver substantially larger welfare gains. The welfare gain of switching to the optimal lifetime income tax ranges from 10.1% to 22.3% of household lifetime consumption, contingent upon interest rate's responsiveness to income tax adjustments, whereas the welfare gain achievable with the optimal annual income tax is only about 1.0%. Lifetime income tax is more efficient at redistributing income, and hence the optimal lifetime income tax is more progressive than the optimal annual income tax and attains a more equal distribution of consumption.


We study the optimal income tax problem when policymakers have only limited information about household preferences and wage process. We provide conditions that qualitatively determine the impact of such parameter uncertainty on optimal tax policy. To quantify this effect, we build and estimate an incomplete-market life-cycle model of heterogeneous households using a limited-information Bayesian approach with U.S. data. We find that such uncertainty leads to a more progressive optimal income tax policy, resulting in a 5 percentage point increase in the marginal tax rate gap between high- and low-income households. This result is primarily driven by uncertainty about wage process, and the correlations between uncertain parameters and the shape of their posterior distribution play an important role.