Ülo Ennuste Economics

papers and articles in wordpress

NB!NB!NB!: The Case for a Progressive Tax by Peter Diamond Emmanuel Saez


The Case for a Progressive Tax: From Basic

Research to Policy Recommendations

Peter Diamond

Emmanuel Saez






This paper presents the case for tax progressivity based on recent results in optimal tax theory.

We consider the optimal progressivity of earnings taxation and whether capital income should

be taxed. We critically discuss the academic research on these topics and when and how the

results can be used for policy recommendations. We argue that a result from basic research is

relevant for policy only if (a) it is based on economic mechanisms that are empirically

relevant and first order to the problem, (b) it is reasonably robust to changes in the modeling

assumptions, (c) the policy prescription is implementable (i.e., is socially acceptable and is

not too complex). We obtain three policy recommendations from basic research that satisfy

these criteria reasonably well. First, very high earners should be subject to high and rising

marginal tax rates on earnings. Second, low income families should be encouraged to work

with earnings subsidies, which should then be phased-out with high implicit marginal tax

rates. Third, capital income should be taxed. We explain why the famous zero marginal tax

rate result for the top earner in the Mirrlees model and the zero capital income tax rate results

of Chamley-Judd and Atkinson-Stiglitz are not policy relevant in our view.

JEL-Code: H210.


References (in part, üe)


Atkinson, Anthony, Thomas Piketty, and Emmanuel Saez. 2011. “Top Incomes in the Long Run of History”, forthcoming Journal of Economic Literature.

Auerbach, Alan J. 1988. “Capital Gains Taxation in the United States.” Brookings Papers on Economic Activity, 2: 595-631.

Banks, James and Peter Diamond. 2010 “The Base for Direct Taxation,” in Dimensions of Tax Design: The Mirrlees Review, Edited by The Institute for Fiscal Studies (IFS), Oxford University Press for The Institute for Fiscal Studies (Oxford). Chapter 6, p.548-648.

Chamley, Christophe. 2001 “Capital Income Taxation, Wealth Distribution and Borrowing Constraints,” Journal of Public Economics 79, 55–69.

Christiansen, Vidar, and Matti Tuomala. 2008. “On taxing capital income with income shifting.” International Tax and Public Finance, 15: 527–545.

Cremer, Helmuth, and Pierre Pestieau. 2004. “Wealth Transfer Taxation: A Survey of the Theoretical Literature.” in S.C. Kolm and J. Mercier Ythier, eds, Handbook on

Altruism, Giving and Reciprocity, North Holland, Amsterdam.

Diamond, Peter. 1973 “Taxation and Public Production in a Growth Setting,” in J.A.

Mirrlees and N. H. Stern, eds., Models of Economic Growth, MacMillan, London.

Diamond, Peter. 1980. “Income Taxation with Fixed Hours of Work,” Journal of

Public Economics 13, February, 101-110.

Diamond, Peter. 1998. “Optimal Income Taxation: An Example with a U-Shaped

Pattern of Optimal Marginal Tax Rates.” American Economic Review, 88(1): 83-95.

Diamond, Peter. 2003, Taxation, Incomplete Markets and Social Security, the 2000

Munich Lectures, Cambridge: MIT Press.

Diamond, Peter and James Mirrlees. 1986. “Payroll-Tax Financed Social Insurance

with Variable Retirement,” Scandinavian Journal of Economics 88 (1): 25-50.

Diamond, Peter and James Mirrlees. 2000. “Adjusting One’s Standard of Living: Two

Period Models,” in P. J. Hammond and G. D. Myles (eds.), Incentives, Organization, and

Public Economics, papers in Honour of Sir James Mirrlees, Oxford; Oxford University

Diamond, Peter and Johannes Spinnewijn. 2010. “Capital Income Taxes with

Heterogeneous Discount Rates,” MIT working paper, forthcoming American Economic

Journal: Economic Policy.

Farhi, Emmanuel and Iván Werning. 2010a. “Progressive Estate Taxation,” Quarterly

Journal of Economics 125(2), 635-673.

Farhi, Emmanuel and Iván Werning. 2010b. “Insurance and Taxation over the Life

Cycle”, MIT Working Paper.

Golosov, Mikhail, Narayana Kocherlakota and Aleh Tsyvinski. 2003. “Optimal

Indirect and Capital Taxation.” Review of Economic Studies, 70(3): 569-87.

Golosov, Mikhail and Aleh Tsyvinski. 2006. “Designing Optimal Disability Insurance:

A Case for Asset Testing.” Journal of Political Economy, 114(2): 257-69.

Golosov, Mikhail, Maxim Troshkin, and Aleh Tsyvinski. 2009. “A Quantitative Exploration in the Theory of Dynamic Optimal Taxation,” Yale University working

Golosov, Mikhail, Aleh Tsyvinski, and Matthew Weinzierl. 2009. “Preference Heterogeneity and Optimal Commodity Taxation” Yale Working Paper.

Goolsbee, Austan. 2000. “What Happens When You Tax the Rich? Evidence from Executive Compensation.” Journal of Political Economy, 108(1): 352-378.

Gordon, Roger H., and Jeffrey K. MacKie-Mason. 1995. “Why is There Corporate Taxation in a Small Open Economy?” In The Effects of Taxation on Multinational Corporations, eds. Martin Feldstein, James R. Hines, Jr., and R. Glenn Hubbard. Chicago: University of Chicago Press.

Gordon, Roger and Joel Slemrod. 2000. “Are ‘Real’ Responses to Taxes Simply Income Shifting Between Corporate and Personal Tax Bases?” In Joel Slemrod, ed., Does Atlas Shrug? The Economic Consequences of Taxing the Rich, Harvard University Press:

Gruber, Jonathan and Emmanuel Saez. 2002. “The Elasticity of Taxable Income: Evidence and Implications”, Journal of Public Economics, 84: 1-32.

Holmstrom, Bengt. 1979. “Moral Hazard and Observability,” The Bell Journal of Economics, 10(1): 74-91.

Internal Revenue Service. 2009. Statistics of Income: Individual Income Tax Returns for Year 2007, Publication No. 1304, (Washington, DC: Government Printing Press).

Internal Revenue Service. 2009b. “The 400 Individual Income Tax Returns Reporting the Highest Adjusted Gross Incomes Each Year, 1992-2007”, (Washington, DC: Government Printing Press).

Judd, Kenneth. 1985. “Redistributive Taxation in a Simple Perfect Foresight Model.” Journal of Public Economics, 28(1): 59–83.

Judd, Kenneth L. 1999. “Optimal taxation and spending in general competitive growth models,” Journal of Public Economics, 71: 1-26.

Kaplow, Louis. 2006. “On the Undesirability of Commodity Taxation Even When Income Taxation Is Not Optimal.” Journal of Public Economics, 90(6-7): 1235-50.

Kocherlakota, Narayana. 2005. “Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation.” Econometrica, 73(5): 1587-621.

Kocherlakota, Narayana R. 2010. The New Dynamic Public Finance, Princeton, Princeton University Press.

Kopczuk, Wojciech. 2005. “Tax Bases, Tax Rates and the Elasticity of Reported Income,” Journal of Public Economics, 89(11-12): 2093-2119.

Laroque, Guy R. 2005. “Indirect Taxation is Superfluous under Separability and Taste Homogeneity: A Simple Proof.” Economics Letters, 87(1): 141-4.

Mankiw, N. Gregory, and Matthew Weinzierl. 2010. “The Optimal Taxation of Height: A Case Study of Utilitarian Income Redistribution.” American Economic Journal: Economic Policy, 2(1), 155–76.

Mankiw, N. Gregory, Matthew C. Weinzierl, and Danny Yagan. 2009. “Optimal Taxation in Theory and Practice.” Journal of Economic Perspectives 23(4): 147-174.

Meade, James Edward. 1978. The Structure and Reform of Direct Taxation, Report of a Committee chaired by Professor J. E. Meade. London: George Allen & Unwin.

Meyer, Bruce. 2010. “The Effects of the EITC and Recent Reforms”, Tax Policy and the Economy, ed. Jeffrey Brown, (Cambridge: MIT Press), Volume 24.

Pareto, Vilfredo. 1896. “La courbe de la répartition de la richesse”, Ecrits sur la courbe de la répartition de la richesse, (writings by Pareto collected by G. Busino, Librairie Droz, 1965), 1-15.

Piketty, Thomas and Emmanuel Saez. 2003. “Income Inequality in the United States, 1913-1998”, Quarterly Journal of Economics, 118(1), 1-39, series updated to 2007 in August 2009.

Piketty, Thomas and Emmanuel Saez. 2007 “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective”, Journal of Economic Perspectives, 21(1), 3-24.

Pirttilä, Jukka, and Håkan Selin. 2011. “Income Shifting within a Dual Income Tax System: Evidence from the Finnish Tax Reform of 1993.” Scandinavian Journal of Economics, 113(1), 120–144.

Reis, Catarina. 2007. “Entrepreneurial Labour Taxation.” Dissertation chapter, MIT.

Saez, Emmanuel. 2001. “Using Elasticities to Derive Optimal Income Tax Rates”, Review of Economic Studies, 68: 205-229.

Saez, Emmanuel. 2002a. “Optimal Income Transfer Programs: Intensive Versus Extensive Labour Supply Responses.” Quarterly Journal of Economics, 117(2): 1039-73.

Saez, Emmanuel. 2002b. “The Desirability of Commodity Taxation under Non-linear Income Taxation and Heterogeneous Tastes.” Journal of Public Economics, 83(2): 217–

Saez, Emmanuel. 2004. “The Optimal Treatment of Tax expenditures”, Journal of Public Economics, 88(12): 2657-2684.

Saez, Emmanuel, Joel Slemrod, and Seth Giertz. 2011. “The Elasticity of Taxable

Income with Respect to Marginal Tax Rates: A Critical Review”, forthcoming in the Journal of Economic Literature.

Comment: in the present Estonian tax mechanism design situation – anomalously no capital income tax and flat income earning tax in general – the most important  effective policy recommendation in this Paper are in short given on pp 2-3 as First and Third:

We obtain three policy recommendations from basic research that we believe can

satisfy these three criteria reasonably well. First, very high earners should be subject to

high and rising marginal tax rates on earnings. In particular, we discuss why the famous

zero marginal tax rate at the top of the earnings distribution is not policy relevant.

Second, the earnings of low income families should be subsidized and those subsidies

should then be phased-out with high implicit marginal tax rates. This result follows

because labor supply responses of low earners are concentrated along the margin of

whether to participate in labor markets at all (the extensive as opposed to the intensive

margin). These two results combined imply that the optimal profile of transfers and taxes

is highly nonlinear and cannot be well approximated by a flat tax along with lump sum

“demogrants.” Third, we argue that capital income should be taxed. We will review

certain theoretical results—in particular, those of Atkinson and Stiglitz (1976), Chamley

(1986), and Judd (1985)—implying no capital income taxes, and argue that these findings

are not robust enough to be policy relevant. In the end, persuasive arguments for taxing

capital income are that there are difficulties in practice in distinguishing between capital

and labor incomes, that borrowing constraints make full reliance on labor taxes less efficient, and that savings rates are heterogeneous.”

Also most important for us in References is a exelent collection of the newest rigorous publications in this field.

The problems of modelling of connected uncertainties and moral hazards are perhaps need some more considerations in the first place!





March 29, 2014 - Posted by | Uncategorized

No comments yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: