Marginal Tax Rates and Income Inequality in a Life-Cycle Model

In this paper, we perform computational counterfactual experiments to examine the quantitative impact of marginal tax rates on the distribution of income. Our methodology builds on previous simulation models developed by Auerbach and Kotlikoff and Fullerton and Rogers, and uses an algorithm that allows us to examine marginal tax rate structures in their literal form. We find that distortions associated with particular marginal tax rate structures have sizable effects on income inequality in a reasonably quantified life-cycle setting: In our baseline experiments, the change in steady-state income inequality under 1989 U.S. income tax rates vis-à-vis 1984 rates is about half as large as the change actually seen in the data over those two years, when measured in terms of a monetary metric derived from Gini coefficients.