Working Papers



September 2013, No. 13-13R

A Road Map for Efficiently Taxing Heterogeneous Agents (Revised July 2014)

Marios Karabarbounis

This paper evaluates the quantitative potential of a tax system that depends on a rich set of household characteristics, such as the person's age, his/her financial assets, and the number of working members in his/her household. The justification for this kind of reform is that workers respond differently to wage changes depending on how close they are to retirement, how wealthy they are, and whether they are the main financial provider in the family. Using a life-cycle model with heterogeneous, two-member households, I find that it is optimal to decrease tax rates on younger and older workers, wealthier households that are closer to retirement, and two-earner households. The government can raise revenues by targeting workers with a low value of labor supply elasticity, such as middle-aged workers living in a single-earner family. This new system generates large gains: Total supply of labor increases by 3.17%, the capital stock by 8.37%, and consumption by 4.88%.

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