Optimal Taxation and the Great MTR Pivot

• In Event: Consumption Taxes, Fines, and Social Safety Nets

Abstract

Over the past 40 years, the U.S. system of transfers to lower income families has been transformed in a way to increase incentives to work. The new system has been termed the ``Work-Based Safety Net.'' What is not fully understood is that any reduction in marginal tax rates in transfer programs for low income families must generate a corresponding increase in marginal tax rates higher in the earnings distribution, at least if it is to be focused on low income families. This paper analyzes this question by making three contributions. First, we provide a comprehensive accounting of all major transfer programs and calculate new cumulative marginal tax rates for individuals participating in different combinations of programs and how they have changed over time. Second, we calibrate a static structural labor supply model to CPS data over the period 1983-2014, using the results from the literature on the labor supply effects of each major transfer program, making our fitted labor supply function fully consistent with the literature. We use the calibrated model to estimate the impact of the Work-Based Safety Net on labor supply, including the effect of higher marginal rates in higher ranges of earnings as well as the effect of the lower marginal rates at lower levels of earnings. Third, we show how the transformation has affected social welfare, holding total expenditure fixed, using a variety of social welfare functions that incorporate inequality aversion. Optimal schedules are then computed for each level of total expenditure.

Authors

• Robert Moffitt, Johns Hopkins University

• John Green

• Emma Kalish