Faculty of Arts and Social Sciences
Quantifying the Welfare Gains from History Dependent Income Taxation
May 2, 2018, Wednesday
11.45-13.00 FASS 2034
I quantify the welfare gains from introducing history dependent income tax in an incomplete markets framework where individuals face uninsurable idiosyncratic shocks. I assume that the income tax paid is a function of a geometrical weighted average of past incomes, and solve for the optimal weights. I find that the two main factors that determine the nature of history dependence are the degree of mean reversion in the productivity process and the discount factor.
Starting with the best history independent tax system, the welfare gains from history dependence itself are about 0.78 percent of consumption. I decompose the total effect into an efficiency effect that increases labor supply, and an insurance effect that reduces volatility of consumption and find that, quantitatively, the insurance effect strongly dominates the efficiency effect.