Events at CERGE-EI

Pavel Brendler, Ph.D.

University of Bonn, Germany

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Author: Pavel Brendler

Abstract: Cross-sectional earnings inequality has risen sharply since the late 1970s in the United States. I ask: How should the government optimally respond to this development? I set up a rich quantitative model in which a Ramsey government optimally decides on income taxation and Social Security and is able to discriminate agents by their age and education. I find that the optimal income tax and Social Security system induces a welfare gain to U.S. households equal to 1.2% in consumption equivalent terms compared to the status quo. Quantitatively, three factors exert the most pronounced impact on the optimal solution: 1) a larger dispersion in initial skills and innate abilities between college graduates and non-college graduates, 2) a higher variance in the education-specific fixed effects, and 3) a widening gap in education-specific mortality rates.

JEL Classification: D3, E6, H2, H3
Keywords: Optimal tax, Income taxation, Public pension program, Earnings inequality, Idiosyncratic risk

Full Text: Rising Earnings Inequality and Optimal Income Tax And Social Security Policies