Heterogeneous labor skills, the median voter and labor taxes

This paper analyzes the median voterʼs most preferred sequences of labor taxes in the standard neoclassical growth model. We consider an infinite horizon economy in which agents are heterogeneous with respect to both initial wealth and labor skills. We start by providing a set of sufficient conditions for the existence of a Condorcet winner. We then characterize the most preferred tax sequence by the median agent. First, we show that marginal labor taxes depend directly on the absolute value of the distance between the median and the mean value of the skillsʼ distribution. Second, we find that in contrast to the intuition stemming from standard representative agent economies, labor taxes are more volatile and counter-cyclical taxation (e.g., increasing taxes in recession) might be optimal depending on the correlation between inequality and TFP. To assess the quantitative relevance of these findings, we calibrate the model economy to six countries and find that counter-cyclical labor taxation is optimal for all but the US.

► Median voter equilibrium in the stochastic Neoclassical Growth model.
► Heterogeneous labor skills and heterogeneous initial wealth with complete markets.
► Provide sufficient conditions for existence of Condorcet winner.
► Closed form solution for labor tax, pro- or counter-cyclical.
► Intertemporal tax shifting drives to optimal pro-cyclical fiscal policy.