Endogenous longevity and optimal tax progressivity

Abstract

We study the impact of endogenous longevity on optimal tax progressivity and inequality in an overlapping generations model with skill heterogeneity. Higher tax progressivity decreases both the longevity gap and net income inequality, but at the expense of lower average lifetime and income. We find that the welfare-maximizing income tax is less progressive in our model with endogenous longevity than in our model with exogenous longevity. In a highly stylized calibration of the US economy, we show that optimal tax progressivity is less than what prevails under the current US tax system. Our results are robust to the range of empirical labor supply elasticity and the assumptions of missing annuity markets and stochastic health. Our conclusion for the optimal progressivity of the US tax system can be altered by the adoption of a more egalitarian welfare function or by increases in prevailing levels of wage inequality.