Heterogeneity and Government Revenues: Higher Taxes at the Top?, Working Paper

We evaluate the effectiveness of a more progressive tax scheme in raising government revenues. We develop a life-cycle economy with heterogeneity and endogenous labor supply, parameterized to reproduce a host of aggregate and cross-sectional observations for the U.S. economy. Households face a progressive income tax schedule, mimicking the Federal Income tax, and flat-rate taxes that capture payroll, state and local taxes and the corporate income tax. We find that a tilt of the Federal income tax schedule towards high earners leads to small increases in revenues which are maximized at an effective marginal tax rate of about 36.1 % for the richest 5 % of households – in contrast to 21.3 % marginal rate in the benchmark economy. Maximized revenue from Federal income taxes is 7.7 % higher than it is in the benchmark economy, while revenues from all sources increase only by about 1%. The room for higher revenues from more progressive taxes is even lower when the average taxes are higher to start with. We conclude that these policy recommendations are misguided if the aim is to exclusively raise government revenue