Larger transfers financed with more progressive taxes? On the optimal design of taxes and transfers

Pre-print, Working paper: We study the optimal joint design of targeted transfers and progressive income taxes. We develop a simple analytical model and demonstrate an optimally negative relation between transfers and income-tax progressivity, due to both efficiency and redistribution concerns. That is, higher transfers should be financed with lower income-tax progressivity. We next quantify the optimal fiscal plan in a rich dynamic model calibrated to the U.S. economy. Transfers should be generous and financed with moderate income-tax progressivity. To redistribute while preserving efficiency, average tax-and-transfer rates should be more progressive than marginal rates. Transfers, even if lump-sum, precisely allow to disentangle average from marginal rates. Targeted transfers further implement non-monotonic marginal rates, but generate only modest additional gains relative to a lump-sum transfer. Quantitatively, the left tail of the income distribution determines the optimal size of the transfer, while the right tail drives the optimal income-tax progressivity.

Author(s)

Axelle Ferriere, Philipp Grubener, Gaston Navarro, Oliko Vardishvili

Date of publication
  • 2021
Keywords JEL
E21 E62 H21 H23 H53
Keywords
  • Heterogeneous Agents
  • Fiscal Policy
  • Optimal Taxation
  • Redistribution
Internal reference
  • PSE Working Papers n°2021-66
Pages
  • 46 p.
Version
  • 1