Abstract:
We study how idiosyncratic income risk shapes the aggregate and distributional effects of labor and capital income taxation in dynamic general equilibrium models. To this end, we compare a heterogeneous-agent (HA) model with uninsurable idiosyncratic labor productivity risk and a ten-representative-agent (TE) model in which households correspond to fixed wealth deciles without such risk. At the aggregate level, both models generate qualitatively similar responses; however, the HA model exhibits a smaller recessionary impact driven by precautionary savings behavior, which stabilizes investment. At the distributional level, the models differ sharply. In the HA framework, tax shocks trigger endogenous mobility across wealth deciles. These inter-decile transition dynamics tend to benefit lower deciles. In contrast, the TA model features fixed household positions. Our findings highlight that while simpler multi-representative-agent models can approximate aggregate dynamics well, they may miss important distributional adjustment channels. The relevance of these mechanisms ultimately depends on the empirical importance of mobility across the wealth distribution, pointing to a key trade-off between model simplicity and accuracy.
