The surprising power of age-dependent taxes

This paper provides a new, empirically-driven application of the dynamic Mirrleesian framework by studying a feasible and potentially powerful tax reform: age-dependent labor income taxation. I show analytically how age dependence improves policy on both the intratemporal and intertemporal margins. I use detailed numerical simulations, calibrated with data from the U.S. PSID, to generate robust policy implications: age dependence (1) lowers marginal taxes on average and especially on high-income young workers, and (2) lowers average taxes on all young workers relative to older workers when private saving and borrowing are restricted. Finally, I calculate and characterize the welfare gains from age dependence. Despite its simplicity, age dependence generates a welfare gain equal to between 0.6 and 1.5 percent of aggregate annual consumption, and it captures more than 60 percent of the gain from reform to the dynamic optimal policy. The gains are due to substantial increases in both efficiency and equity. When age dependence is restricted to be Pareto-improving, the welfare gain is nearly as large.