Rethinking the Efficiency-Redistribution Trade-Off: Taxes, Transfers, and Household Inequality

forthcoming

Income and wealth inequality have surged in OECD economies over recent decades, sparking renewed debates on the optimal tax-and-transfer system. How should governments design redistribution to the poor? Which taxes should be used to finance the safety net? This proposal consists of three projects combining rich quantitative models with analytical and empirical insights to push the frontier on our understanding of the efficiency-redistribution trade-off. Part I explores how to design income support to the poor. Since the 1980s, many OECD economies have reformed their safety net and introduced work requirements for several welfare programs. Work requirements foster efficiency as they incentivize labor supply but limit redistribution to the poorest. We document the shift in the distribution of transfers across households in the United States since the 1980s and quantify the optimal balance between standard means-tested transfers and those conditional on work requirements. Part II explores how to adjust consumption taxes in recessions. Consumption taxes make up a large share of fiscal revenue in OECD economies, yet their regressive nature raises distributional concerns. Temporary consumption tax cuts have been recently proposed to fight recessions, with the joint goal of easing the burden on the poor and stabilizing the economy. We theoretically and quantitatively analyze the stabilization properties of temporary consumption tax cuts. Part III explores how to raise revenues from the wealthy. Capital income taxes have been regularly proposed to finance redistribution, with no consensus on their efficiency cost. High capital income likely reflects skills of investors selecting productive private businesses, but it may also stem from the market power of wealthy investors. We examine the nature of high returns of investments in private businesses of the wealthy in Norway, and quantify their implications for the optimal level of capital taxes.