Optimal progressivity of the income tax code for Turkey

The focus of this paper is to compute the optimal progressivity of the income tax code for Turkish tax system. Following [Conesa and Krueger, 2006], we employ a dynamic general equilibrium model with heterogeneous agents. Labor productivity shocks in the absence of insurance markets create more dispersed income and wealth distribution. A progressive tax system serves as a partial insurance mechanism. Thus, progressivity decreases differences in income that occur during good times and bad times and enhances welfare. On the other hand, progressive taxation distorts incentives for labor supply and saving decisions of private households. The policy maker, thus faces nontrivial trade-offs between the three effects of progressive taxation; social insurance, equity and labor supply efficiency when designing the income tax code. A flat tax rate of 23% with a fixed deduction of half of the average income, which is roughly 3800TL, maximizes the utilitarian steady state welfare criterion. A tax reform towards this tax system results in welfare gains which is equivalent to 6.2% higher consumption in every possible state of world. Analysis of the Gini coefficients indicates that under the optimal tax system, income, wealth and consumption are more equally distributed.