Optimal Dynamic Taxation: From Theory Toward Policy

This dissertation contributes to our understanding of the economics of optimal taxation in dynamic stochastic economies with heterogeneously productive workers.;We start by arguing in Chapter 2 that a large body of research on optimal taxation has been developing in two directions which both deliver important and often complementary insights. We argue that merging the two approaches can prove beneficial. This guides our analysis in Chapter 3.;In Chapter 3 we first derive formulas that facilitate interpretation of the forces determining optimal distortions in dynamic settings. The formulas extend previous static analyses and bring significant novel insights. Our second set of results is to show that labor distortions tend to zero for sufficiently high skills under certain conditions in both the i.i.d. case and in the case of persistent shocks. This is in sharp contrast to the previous static results. Our third contribution is to numerically simulate the optimal labor and savings distortions over lifecycle in a realistically calibrated economy with empirical income distributions. The computed optimal dynamic distortions differ significantly from the static ones, highlighting the importance of the forces in the theoretical analysis. The welfare gains compared to optimal linear taxes are non-trivial in the case of the utilitarian planner and are significant for a more redistributive Rawlsian criterion.;Chapter 4 develops a novel implementation of the optimal allocations studied in Chapter 3. We show that a tax system based on a straightforward yet practical idea of consolidated income accounts (CIA) implements the optimum. The labor income tax depends on the current labor income and on the balance on the CIA. The savings tax depends only on the amount of current savings. The CIA balance is then updated as a function of the labor income and the previous balance.