NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Redistributing the Gains From Trade Through Progressive Taxation

Spencer G. Lyon, Michael E. Waugh

NBER Working Paper No. 24784
Issued in June 2018
NBER Program(s):Economic Fluctuations and Growth Program, International Trade and Investment Program, Public Economics Program

Should a nation's tax system become more progressive as it opens to trade? Does opening to trade change the benefits of a progressive tax system? We answer these question within a standard incomplete markets model with frictional labor markets and Ricardian trade. Consistent with empirical evidence, adverse shocks to comparative advantage lead to labor income losses for import-competition-exposed workers; with incomplete markets, these workers are imperfectly insured and experience welfare losses. A progressive tax system is valuable, as it substitutes for imperfect insurance and redistributes the gains from trade. However, it also reduces the incentives for labor to reallocate away from comparatively disadvantaged locations. We find that optimal progressivity should increase with openness to trade with a ten percentage point increase in openness necessitating a five percentage point increase in marginal tax rates for those at the top of the income distribution.

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Document Object Identifier (DOI): 10.3386/w24784

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