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Taxation and Income Distribution Dynamics in a Neoclassical Growth Model

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  • The paper has benefited from seminar presentations at the Free University of Berlin, at GREQAM, and at Washington State University, as well as presentations at the conference “Growth with Heterogeneous Agents: Causes and Effects of Inequality,” Marseille, June 2008; the 14th Conference on Computation in Economics and Finance, Paris, June 2008; the 3rd Workshop on Macroeconomic Dynamics, held in Melbourne, July 2008; and, the 2009 PET conference in Galway. Comments received at these various presentations are gratefully acknowledged. In particular, we thank Jess Benhabib, Julio Davila, and Roger Farmer for their comments. The paper has also benefited from the constructive suggestions of two referees and the journal's editor. García-Peñalosa is a CNRS researcher at GREQAM (Aix-Marseille University), and would like to acknowledge the support received from the French National Research Agency Grant ANR-08-BLAN-0245-01.Turnovsky's research was supported in part by the Castor endowment at the University of Washington.

Abstract

We examine how changes in tax policies affect the dynamics of the distributions of wealth and income in a Ramsey model in which agents differ in their initial capital endowments. The endogeneity of the labor supply plays a crucial role, as tax changes that affect hours of work will affect the distribution of wealth and income, reinforcing or offsetting the direct redistributive impact of taxes. We consider different ways of financing government expenditure and find that policies that reduce the labor supply are associated with lower output but also with a more equal distribution of after-tax income. We illustrate these effects by examining the impact of recent tax changes observed in the United States and in European economies.

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