On the Optimality of Age-Dependent Taxes and the Progressive U.S. Tax System

The behavioral implications of a tax system are determined by its marginal tax rates. In life-cycle economies, where an individual’s optimal consumption-work plan is almost never constant, the optimal marginal tax rates on capital and labor income vary with age. Conversely, the U.S. tax code implies marginal tax rates that vary with age because tax rates vary with earnings and earnings vary with age. The question that arises is how close are the marginal tax rates derived from our life-cycle model to those faced by an average individual in the U.S. economy? We find that the age-profile of the labor income tax implied by the U.S. tax code is close to the optimal profile. The age-profile of the capital income tax implied by the U.S. tax code is, however, far from the optimal one, both in level and in shape. (JEL E62, H21) ∗We would like to thank Daniel Feenberg from the NBER for calculating and providing us with the tax rates from the CPS data, and Huberto Ennis for helpful comments