Heterogeneity and Government revenues: Higher taxes at the top?

• We develop a life-cycle economy with heterogeneity and endogenous labor supply.
• Model matches inequality data including the shares of labor income for top earners.
• Shifting the income tax schedule towards high earners leads to small revenue gains.
• Maximal revenue in long run is only 6.8% higher than in benchmark.
• Policies of this sort are misguided if the aim is just to raise revenue.

How effective is a more progressive tax scheme in raising revenues? We answer this question in a life-cycle economy with heterogeneity across households and endogenous labor supply. Our findings show that a tilt of the U.S. income tax schedule towards high earners leads to small increases in revenue. Maximal revenue in the long run is only 6.8% higher than in our benchmark – about 0.8% of initial GDP – while revenues from all sources increase by just about 0.6%. Our conclusions are that policy recommendations of this sort are misguided if the aim is to exclusively raise government revenue.