Redistributive Taxation and Long-Run Income Inequality

Impacts of redistributive taxes on inter-cohort and intra-cohort in-come inequality are generated by long-run responses in precautionary savings and bequests. In a life-cycle overlapping-generations model with earnings risk, uncertain lifetime and nonaltruistic bequests, the long-run income inequality results from the dynastic accumulation of idiosyncratic shocks. This model is used to compare the short- and long-run e¤ects on income distribution of alternative redistributive tax schemes. Economic process of earning, wealth, income, consumpation and savings are studied for a dynamic economy with heteregenous overlapping agents. Agents minimise income uncertainty and risk by engaging themselved in precau-tionary savings. Variances of consumtpion, saving and wealth are signif-icantly lower than the variance of income and earning. The progressive taxation in presence of precautionary saving causes further increase in income inequality contrary to traditional beliefs on egalitarian nature of such taxes