Essays on the political economy of taxation in dynamic settings.

Abstract

In this thesis we explore the relationship between changes in labor income inequality and movements in labor taxes over the last decades in US. In order to do so, we model this link through a political economy channel by developing a median voter result over sequence of taxes. We consider an infinite horizon economy in which agents are heterogeneous with respect to both initial wealth and labor skills. We study indirect preferences over redistributive fiscal policies - sequences of affine taxes on labor and capital income - that can be supported as a competitive equilibrium. The thesis assumes balanced growth preferences and full commitment. The first result is the following: if initial capital holdings are an affine function of skills, then the best fiscal policy for the agent with the median labor skill is preferred to any other policy by at least half of the individuals in the economy. The second result provides the characterization of the most preferred tax sequence by the median agent: marginal taxes on labor depend directly on the absolute value of the distance between the median and the mean value of the skill distribution. In order to analyze the co-movement properties of labor taxes, we extend the above results to an economy in which the distribution of skills evolves stochastically over time. We find that a temporary increase in inequality could imply either higher or lower labor taxes, depending on the sign and level of the correlation between inequality and aggregate labor. We also numerically calculate a calibrated version of the model and we compare the results with the data. The model does a good job on fitting the increasing trend of labor taxes in the last decades and also on matching some short run co-movements. Regarding capital taxation, the bang-bang result holds as in Bassetto and Benhabib (2006). We also generalize the median voter theorem when there is no commitment by adopting the same equilibrium definition as in Bernheim and Slavov (2008).