Progressive Taxation and Long‐Run Income Inequality Under Endogenous Growth

ABSTRACT In accordance with strong empirical evidence that casts doubt on the conventional Cobb‐Douglas technological specification, this paper examines the long‐run macroeconomic effects of progressive income taxation in a one‐sector endogenous growth model with heterogeneous households and a non‐unitary elasticity of substitution between productive capital and labor inputs. In a simplified two‐type version of the baseline macroeconomy, we analytically show that higher fiscal progression leads to less unequal long‐run gross/net income distributions, provided the general‐equilibrium elasticity of aggregate labor supply surpasses a specific negative threshold. This inequality‐growth relationship is found to hold for all variants of our model under consideration. Numerical simulations find that under either productivity‐enhancing or utility‐generating public expenditures, together with the elasticity of substitution in intertemporal‐consumption/production taking on the highest/lowest possible value regarded as empirically plausible, our fully‐calibrated model to OECD data with five types/quintiles is able to generate qualitatively as well as quantitatively realistic long‐run disposable‐income inequality effects of changing the tax progressivity vis‐à‐vis recent panel estimation results. We also numerically study how more progressive taxation affects the economy's long‐run social welfare and output growth rate with useless or useful government spending.