Insurance and Taxation over the Life Cycle / Emmanuel Farhi, Iván Werning.

Format:

Book

Author/Creator:

Farhi, Emmanuel.

Contributor:

National Bureau of Economic Research.

Werning, Iván.

Series:

Working Paper Series (National Bureau of Economic Research) no. w16749.

NBER working paper series no. w16749

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

We consider a dynamic Mirrlees economy in a life cycle context and study the op- timal insurance arrangement. Individual productivity evolves as a Markov process and is private information. We use a first order approach in discrete and continuous time and obtain novel theoretical and numerical results. Our main contribution is a formula describing the dynamics for the labor-income tax rate. When productivity is an AR(1) our formula resembles an AR(1) with a trend where: (i) the auto-regressive coefficient equals that of productivity; (ii) the trend term equals the covariance pro- ductivity with consumption growth divided by the Frisch elasticity of labor; and (iii) the innovations in the tax rate are the negative of consumption growth. The last prop- erty implies a form of short-run regressivity. Our simulations illustrate these results and deliver some novel insights. The average labor tax rises from 0% to 46% over 40 years, while the average tax on savings falls from 17% to 0% at retirement. We com- pare the second best solution to simple history independent tax systems, calibrated to mimic these average tax rates. We find that age dependent taxes capture a sizable fraction of the welfare gains. In this way, our theoretical results provide insights into simple tax systems.

Notes:

Print version record

January 2011.