Francesca Parodi (UCL)

“Taxation of Durables, Non-durables and Earnings with Heterogeneous Preferences”

Abstract

Consumption and personal income taxes are key policy instruments. They are both major sources of government revenue and defining elements in social insurance and redistribution policies. In this paper, I adopt a dynamic structural approach to study the design of these taxes and their interactions. I develop a life-cycle model of household consumption, saving and employment choices with heterogeneous preferences, multiple non-durable goods and partially irreversible durables. I estimate the model on micro data and show that its rich structure is key in reproducing the empirical patterns of households’ life-cycle economic behavior. I then use the estimated model to quantitatively characterize the optimal tax rates on different commodities and on labor income in a utilitarian framework and under alternative scenarios of preference heterogeneity. I find that durables should be subsidized in presence of pre-commitment and uncertainty and that the optimal combination of taxes on non-durables and labor income crucially depends on the degree of preference heterogeneity. Allowing for a more general social welfare criterion with varying degrees of government inequality aversion, I show that the model can rationalize the tax systems observed in reality and that differentiated consumption taxes – with higher rates on durables – serve a redistributive purpose jointly with the progressivity of labor income taxes.