Discussion Paper Series 2012-E-1

Optimal Dynamic Taxes

Mikhail Golosov, Maxim Troshkin, Aleh Tsyvinski

We study optimal labor and savings distortions in a lifecycle model with idiosyncratic shocks. We show a tight connection between its recursive formulation and a static Mirrlees model with two goods, which allows us to derive elasticity-based expressions for the dynamic optimal distortions. We derive a generalization of a savings distortion for non-separable preferences and show that, under certain conditions, the labor wedge tends to zero for sufficiently high skills. We estimate skill distributions using individual data on the U.S. taxes and labor incomes. Computed optimal distortions decrease for sufficiently high incomes and increase with age.

Keywords: Optimal taxation; Efficiency; Optimal Social insurance

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2012 Bank of Japan All Rights Reserved.

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