Efficient Redistribution with Consumption Taxes; Patrick Macnamara (University of Manchester)

Abstract

What is the best way for governments to raise fiscal revenues and provide social insurance in unequal economies? We revisit this question by characterizing the optimal shape of linear consumption taxes in combination with non-linear income taxes in an estimated life-cycle model with uninsurable idiosyncratic risk and wealth return heterogeneity. In our economy, agents who are sufficiently productive can obtain higher returns by choosing to be entrepreneurs. We estimate the model in order to reproduce income and wealth inequality together with a broader set of distributional and macroeconomic moments of the US economy. Optimal policy calls for positive consumption taxation collecting all fiscal revenues, while labor income taxes should be progressive and raise zero revenues on average. Relative to the status quo, labor income taxes should be much more progressive, and the optimal policy would bring welfare gains that are larger than an alternative scenario where the government taxes wealth instead of consumption.