Taxation of Durables, Non-durables and Earnings with Heterogeneous Preferences

In this paper, I adopt a dynamic structural approach to study the design of consumption and personal income taxes and their interactions. I develop a life-cycle model of
household consumption, saving and employment choices with multiple non-durable goods – necessities and luxuries – and partially irreversible durables. I estimate the model on
micro data and use it to quantitatively characterize the optimal tax rates on different commodities and on labor income in a utilitarian framework and under alternative scenarios of preference heterogeneity. I find that durables should be subsidized in presence of pre-commitment and uncertainty and that the optimal combination of taxes on non-durables and income crucially depends on the degree of preference heterogeneity. Allowing for government inequality aversion, I show that the model can rationalize the tax systems observed in reality and that differentiated consumption taxes serve a redistributive purpose jointly with the progressivity of labor income taxes.

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