Larger Transfers Financed with More Progressive Taxes? On the Optimal Design of Taxes and Transfers

Titel: Larger Transfers Financed with More Progressive Taxes? On the Optimal Design of Taxes and Transfers (co-authors: Axelle Ferriere, Gaston Navarro, Oliko Vardishvili)

Abstract: 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.