Redistributing the Gains From Trade Through Progressive Taxation
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.
We would like to thank our discussant Oleg Itskhoki, Gordon Hanson, Stephen Redding, Referees, and participants at the NBER Trade and Labor Markets Conference and Vanderbilt University for valuable comments and suggestions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Forthcoming: Redistributing the Gains from Trade through Progressive Taxation, Spencer Lyon, Michael Waugh. in Trade and Labor Markets, Hanson and Redding. 2018
Spencer G. Lyon & Michael E. Waugh, 2018. "Redistributing the gains from trade through progressive taxation," Journal of International Economics, vol 115, pages 185-202. citation courtesy of