Optimal Income Taxation and Job Choice

In this paper, we study optimal income taxation when different job types exist for workers of different skills. Each job type has some feasible range of incomes from which workers choose by varying labor supply. Workers are more productive than others in the jobs that suit them best. The model combines features of the classic optimal tax literature with labor variability along the intensive margin, with the extensive‐margin approach where workers make discrete job choices and/or participation decisions. We find that first‐best maximin utility can be achieved in the second‐best, and marginal tax rates below the top can be negative or zero.     

Optimal Dynamic Taxation with Distinctive Forms of Social Status Attainment

We examine the role of both consumption‐ and wealth‐induced social comparisons in setting dynamic optimal income taxation. Under complete information, state‐invariant labor income taxes are used to remedy the externality caused by consumption‐induced social comparisons, while state‐contingent capital income taxes are used to remedy the externalities caused by both consumption‐ and wealth‐induced social comparisons. Under incomplete information, distinct types of agents are subject to an identical marginal capital income tax, which removes social comparisons. To solve the information problem, low‐productivity agents could be subject to a lower marginal labor tax than high‐productivity agents, which contradicts the traditional result in the Mirrlees–Stiglitz models.     

Costs of Taxation and Benefits of Public Goods with Multiple Taxes and Goods

The fact that raising taxes can increase taxed labor supply through income effects is frequently and erroneously used to justify greater public good provision than indicated by traditional, compensated analyses. We develop a model including multiple public goods and taxes and derive measures of the marginal benefits of public goods and the Marginal Cost of Funds (MCF) using both compensated and uncompensated measures. We confirm that the desirability of tax‐financed public projects is independent of the method used. An important innovation is to show that the benefits of public goods must be adjusted by a benefit multiplier not previously seen in the literature if an uncompensated MCF is used.     

INTERNATIONAL WELFARE AND EMPLOYMENT LINKAGES ARISING FROM MINIMUM WAGES*

We formulate a two‐country model with monopolistic competition and heterogeneous firms to reconsider labor market linkages in open economies. Labor market imperfections arise by virtue of country‐specific real minimum wages. Abstracting from selection of just the best firms into export status, standard effects on marginal and average firm productivity are reversed in our model, yet there are significant gains from trade arising from employment expansion. In addition, we show that with firm heterogeneity an increase in one country’s minimum wage triggers firm exit in both countries and thus harms workers at home and abroad.     

Growth,Employment and Taxation with Distortions in the Goods and Labour Market

Abstract. This paper analyses taxation in the presence of distortions in goods and labour markets in an endogenous growth model. The government disposes of capital, labour and consumption taxes. It is shown that the market solution leads to suboptimally low levels of growth and employment. However, available tax instruments are sufficient to attain the first‐best growth path in this economy. The paper further explores the relative distortion of capital and labour taxes. For plausible parametrisations of the model, lowering capital taxes dominate reductions in labour taxes in welfare terms.     

Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation

This paper studies optimal capital and labor income taxes when the benefits of public goods are age‐dependent. Provided the government can impose a consumption tax, it can attain the first‐best resource allocation. This involves the uniform taxation of the cohorts' labor income and a zero capital income tax. With no consumption tax and optimally chosen government spending, labor income should be taxed nonuniformly across cohorts and the capital income tax should be nonzero. Deviations of the public goods from their respective optima create distortions. These affect the labor supply decisions of both cohorts and capital accumulation, providing a further reason to tax (or subsidize) capital income.     

Optimal human capital policies under the endogenous choice of educational types

This study examines optimal human capital policies under nonlinear labor and capital income taxes in the presence of consumption value of education in a two‐period setting. We show that when individuals can choose educational types differing by the relative importance of consumption value and production value, education subsidies for low‐type individuals should not equal an efficient level that offsets distortions induced by nonlinear taxes on labor and capital income. Our findings imply that education policy does not restore efficiency, or the Diamond–Mirrlees production efficiency theorem fails. Moreover, capital income taxation is optimal, which means that the Atkinson–Stiglitz theorem breaks down.     

Choosing the right instrument

This paper analyses the optimal choice of second-best optimal environmental policies. Using a partial equilibrium model, the paper first reconfirms the well-known result that the existence of a double dividend (in its weak definition) favours environmental policy instruments which maximise tax revenues for a given improvement in environmental quality. Additional revenues can be used to reduce the distortion of existing taxes such as taxes on labour and capital income. Without uncertainty, environmental taxes and auctioned permits are equally appropriate. In the presence of uncertainty, however, the optimal choice of taxes or tradable permits depends on the relative magnitudes of the marginal environmental damage and the marginal benefit from consuming a polluting good. In the second part, the paper, therefore, analyses how the revenue capacity affects the optimal choice of environmental policy instruments in the presence of uncertainty. The paper shows that the first-best choice rule between price and quantity regulation (Weitzman, 1974) remains valid in a second-best world with distortionary taxation.     

A Discriminatory Mechanism to Reduce Urban Congestion

In this article, we propose an optimal mechanism to reduce congestion when information is asymmetric. Each car driver receives a quantity of traffic rights such that his adjusted marginal benefit is equal to the marginal cost of congestion and payments are based on willingness to pay. We show that the level of congestion achieved is lower and each car user can receive more or fewer rights than under complete information. With symmetric beliefs, the payment rule results from a second‐degree price discrimination. When beliefs are asymmetric, it results simultaneously from a second‐degree price discrimination and from a third‐degree price discrimination and high willingness‐to‐pay car users are discriminated against. The revenue raised can be used to reduce distortionary taxes, thereby gaining public acceptability.     

Commodity taxes and welfare under endogenous market conduct

We consider consumption taxes in a model of endogenous Cournot versus Bertrand competition. It is argued that when the choice of unit versus ad valorem taxes affects longer-term decisions beyond the customary price or quantity decisions, the mix of the two taxes co-determines market conduct. This gives ad valorem taxes an anti-competitive effect that harms ad valorem taxes’ efficiency in comparison with unit taxes. We show that a mix of the taxes—or a unit tax alone if we compare one or the other of the taxes—is sometimes welfare superior on account of consumer-price and tax revenue effects. A practical implication of our findings is that pass-through rates are only sometimes useful guides for policy. In fact, we show when the proper response to demand for higher revenue is a higher unit tax rate and a lower ad valorem tax rate.     

Consumption adaptation,anticipation‐bias,and optimal income taxation

Adaptation is omnipresent but people systematically fail to correctly anticipate the degree to which they adapt, leading them to make irrational intertemporal decisions. This paper concerns optimal income taxation to correct for such anticipation‐biases in a framework where consumers adapt to earlier consumption levels. The analysis is based on a general equilibrium OLG model with endogenous labor supply and savings where each consumer lives for three periods. The results show how a paternalistic government may correct for the effects of anticipation‐bias through a combination of time‐variant marginal labor income taxes and savings subsidies/taxes. The optimal policy mix remains the same, irrespective of whether consumers commit to their original life time plan for work hours and consumption or reoptimize later on when realizing that they have already adapted more than expected.     

Welfare states and unemployment

Summary This paper studies equilibrium unemployment in a search model where the government both provides liberal unemployment insurance and taxes labor at high progressive tax rates. It is shown how progressive income taxation can counteract a high unemployment rate under generous unemployment insurance. In particular, high marginal taxes reduce workers' incentives to switch jobs in response to changing economic opportunities. This lower labor mobility reduces unemployment but at the cost of a less efficient labor allocation.We are grateful to William Dupor, Krishna Kumar, and Ashok Rai for excellent computer programming.     

Trade,environment, and income inequality: An optimal taxation approach

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor), and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under‐ or over‐internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade‐off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income toward the unskilled results paradoxically in less pollution and more income inequalities.     

The effects of longevity and distortions on education and retirement

This article studies the impact of longevity and taxation on life-cycle decisions and long run income. Individuals allocate optimally their total lifetime between education, working and retirement. They also decide at each moment how much to save or consume out of their income, and, after entering the labor market, how to divide their time between labor and leisure. The model incorporates experience–earnings profiles and return to education function that follows evidence from the labor literature. In this setup increases in longevity raises the investment in education—time in school—and retirement. The model is calibrated to the US and is able to reproduce observed schooling trends of the last century. It also reproduces the increase in retirement, as the evidence shows. Simulations show that a country equal to the US but with 20% smaller longevity will be 25% poorer, mostly because of the impact of life expectancy on human capital formation and retirement. In this economy labor taxes have a strong impact on the per capita income, as it decreases labor effort, time at school and retirement age, in addition to the general equilibrium impact over physical capital.     

Endogenous trade policy in general equilibrium: An interaction of redistribution rule,trade openness,and labor market condition

Using a general equilibrium framework, the paper derives trade policy endogenously for a small country. It shows that, contrary to the existing literature, a lobbying industry is not guaranteed trade protection; it may even face trade taxes. Besides lobbying, trade policy depends on other factors such as the trade revenue distribution rule, income distribution across groups, trade openness, factor substitutability in production, industry employment size, and labor market flexibility. The paper also shows that the observed phenomenon of government preference for import tariffs over export subsidies—a long overdue puzzle—is an inherent outcome of lobbying equilibrium. It also shows that trade policies such as import tariffs and export taxes that have the same impact on economic market—Lerner symmetry (1936)—are driven by the same forces in the political market.     

A many-person Ramsey tax rule

Define the social marginal utility of an individual's income as the gain to society of a unit of consumption by the individual plus the value of his marginal propensity to pay taxes out of income. This concept rather than the social marginal utility of consumption (equal to the first term above) seems helpful in understanding optimal tax first order conditions. For example, with many consumers (and a poll tax as well as excise taxes) the change in aggregate compensated quantity demanded is proportional to the covariance between individual quantities demanded and social marginal utilities of income.     

PRICING,CAPACITY, AND CONSTRUCTION BOUNDARY OF A CONGESTIBLE HIGHWAY WITH AN ELASTIC DEMAND: SOCIAL OPTIMUM,SECOND BEST,PRIVATIZATION, AND VERTICAL DISINTEGRATION*

This paper uses a spatial model to analyse first‐ and second‐best policies, impacts of privatization and vertical disintegration of a congestible highway with elastic demand. The paper also uses simulation methods to analyse the welfare cost of a uniform‐toll constraint. Results show, inter alia, that the social optimum requires the marginal cost of highway extension to be equal to the net consumer benefit at the boundary, while in the second‐best case the aggregate user cost must be measured in terms of the shadow price. In turn, a profit‐maximizing firm equates the marginal extension cost to the markup revenue at the boundary.     

Higher Tax for Top Earners

The literature can justify both increasing and decreasing marginal taxes (IMT & DMT) on top incomes under different welfare objectives and income distributions. Even when DMT are theoretically optimal, they are often politically infeasible. Then a flat tax seems to be a constrained optimal solution. We show however that, given any flat tax we can increase the total utility of a poor majority by raising the top income tax rate under a simple condition, which can be checked with empirical data. We further generalize our main results allowing different welfare weights, declining elasticity of labor supply and more tax bands.     

Heterogeneous labor skills,the median voter and labor taxes

This paper analyzes the median voter?s most preferred sequences of labor taxes in the standard neoclassical growth model. We consider an infinite horizon economy in which agents are heterogeneous with respect to both initial wealth and labor skills. We start by providing a set of sufficient conditions for the existence of a Condorcet winner. We then characterize the most preferred tax sequence by the median agent. First, we show that marginal labor taxes depend directly on the absolute value of the distance between the median and the mean value of the skills? distribution. Second, we find that in contrast to the intuition stemming from standard representative agent economies, labor taxes are more volatile and counter-cyclical taxation (e.g., increasing taxes in recession) might be optimal depending on the correlation between inequality and TFP. To assess the quantitative relevance of these findings, we calibrate the model economy to six countries and find that counter-cyclical labor taxation is optimal for all but the US.