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Higher taxes at the top? The role of tax avoidance

Abstract:

How does the presence of endogenous tax compliance alter optimal taxation in the United States? Using a full-scale macroeconomic model augmented with endogenous tax avoidance, I show that extremely high marginal tax rates for top earners cannot be sustained in equilibrium. Revenue- and welfare-maximising tax rates range between 36.4% and 38.4% in the long run, which are very close to the status quo. These results are robust to the calibration of the labour supply's Frisch elasticity, and the labour response explains, at most, 60% of the variation of taxable income in the short run. Moreover, tax hikes on top earners are not effective redistribution mechanisms in the presence of tax avoidance.