Taxing the Rich: The Trade-offs of Redistribution.

Income inequality is a growing concern for economists, politicians, and policymakers. On one hand, a progressive tax system can reduce income and wealth inequality, which is welfare improving. On the other hand, it also distorts labor and investment decisions, generating social costs. In the TaxRich project we study the trade-offs between social equality and efficiency that emerge as a consequence of alternative progressive tax schemes. Our focus is on the role of entrepreneurs in the economy. This project comprises two distinct yet interconnected components, each delving into different aspects of taxation and its broader economic implications.   Entrepreneurs are an important driving force behind economic growth. Their ability to generate new technologies increase business income, employment, and wealth. In the first part of this project, we investigate how these entrepreneurs, in Norway, influenced by the tax structure, contribute to the economy. We will examine how their income-generation capabilities evolve over time and how tax policies impact their efforts. We will use a quantitative model to explore the trade-offs that different tax systems entail. For instance, wealth and inheritance taxes could generate similar fiscal revenues, but their impact in the economy may differ in the short and long-run.   The second part of the project, shifts focus to countries with significant informal economies, using Chile as a case of study. Here, we confront the challenge of limited information on wealth distribution due to the informal sector. By accessing comprehensive tax records in Chile, we will gain insights into the determinants of wealth and income across individuals. We plan to incorporate the concept of informality into a standard macroeconomic model. We will analyze the optimal tax structure and the transitional costs associated with moving from the current tax system to one that can, eventually, reduce income/wealth inequality.

This project, which we call TaxRich hereafter, will study the trade-offs that a planner or government faces when taxing the rich individuals in the economy. Our project consists of two sub-packages. First, we develop a model where entrepreneurs are heterogeneous in their ability to generate business income and whose entrepreneurial effort depends, in part, on the tax structure of the economy. To be able to test the relevance of the mechanism that are present in the model, we will first analyze the behavior of entrepreneurs. More specifically, we will generate new facts about the population of entrepreneurs over their life cycle, in Norway. We will identify "types" and "scale" dependence as a mechanism that generates return heterogeneity. We will use the quantitative model, fitted to Norwegian data, to study policy trade-offs induced by alternative tax systems. We will analyze the relative benefits, and costs, of a wealth tax versus an inheritance taxes. Our analysis will be done in terms of wealth dynamics, efficiency gains, changes in income and wealth distribution and, more importantly, social welfare. Second, we study the optimal taxation problem in an economy with incomplete markets, where individuals can decide to be part of the informal economy. There is lack of information about the real extent of wealth heterogeneity in developing countries. To overcome this limitation, we will access tax records of all taxpayers in Chile. We will characterize the wealth dynamics, wealth, and income heterogeneity and the distribution of return to business income. Then, we will add, to a standard heterogeneous agent model, informality. We will use the model, calibrated to Chilean data, to analyze a Ramsey problem and explore the transitional cost of moving to the optimal tax structure from the current tax mix.