Location:  368A Heady Hall

Description:  Jonathan Heathcote (FRB Minneapolis) "Optimal Income Taxation:  Mirrlees Mets Ramsey"

Abstract:  We revisit a classic question in public finance: what structure of labor earnings taxation can maximize the social benefits of redistribution and public insurance while minimizing the social harm associated with distorting the allocation of labor input? The current tax and transfer system in the United States redistributes through a combination of tax rates that increase with income, coupled with transfers that decline with income. However, many authors have argued that a more efficient way to redistribute would be to move to a flat tax system, in which marginal tax rates are constant across the income distribution, and redistribution is achieved via non-means-tested transfers. In our preferred model specification, we find that moving to the optimal tax policy in the affine class is welfare reducing, while moving to the optimal fully non-linear Mirrlees policy generates only tiny welfare gains. These findings suggest that proposals for dramatic tax reform should be viewed with caution.