Optimal nonlinear income taxation with a finite population

In the standard optimal income taxation problem, tax payments depend only on each consumer's own actions. Piketty [J. Econ. Theory 61 (1993) 23-41] shows that, if one individual's tax schedule depends on others’ actions and the government knows the exact ability distribution, it can implement any undistorted allocation as the unique revelation game outcome. If some individuals misreveal their types, Piketty's mechanism may assign infeasible allocations. We require that tax schedules must balance the government budget for every possible vector of revelations. When individuals reveal their type by simple announcements, all undistorted allocations can be still implemented, even with off-equilibrium feasibility constraints.     

Optimal nonlinear income taxation with productive government expenditure

This paper develops an endogenous growth model with a production externality and nonlinear income taxation, and uses it to examine how the fiscal authority devises its nonlinear tax structure from the viewpoint of welfare maximization. It is found that, in the Barro (1990) model, Pareto optimality can be achieved if both policy instruments for the tax scalar and the extent of the tax progressivity/regressivity are set optimally.     

Optimal nonlinear taxation of income and savings without commitment

When a government is unable to commit to its future tax policies, information about taxpayers' characteristics revealed by their behavior may be used to extract more taxes from them in the future. We examine the implications of this ratchet effect for the design of redistributive income and savings tax policies in a two‐period model with two types of individuals who only differ in their skill levels. When commitment is not possible, it may be optimal to separate, pool, or partially pool different types in period one. The nature of the distortions to labor supplies and savings are investigated for each of these three regimes. The identification of the optimal regime is investigated numerically.     

Optimal income taxation when couples have endogenous bargaining power

This study examines the optimal income taxation for a two-earner household, where the couple bargains over their private goods consumption and time allocation between work and leisure. In the model, bargaining power is determined endogenously by the income gap between the two earners. Conventional studies have shown that the higher income tax rate should be imposed on the individual with the smaller wage elasticity, typically the individual with the higher productivity. In contrast to conventional argument, this study shows that the optimal tax rate on the household member with the higher productivity is lower than that of the individual with the lower productivity if the required tax revenue is relatively small and the influence of the gender income gap on the power balance of the couple is moderate. This is because such a tax structure encourages the labor supply of the individual with the higher productivity to mitigate the decrease in the household’s consumption induced by income taxation.     

Optimal taxation in the extensive model

We study optimal taxation under extensive preferences: the agents? utilities are constant for positive actions up to a maximal productivity level. Utilities may be discontinuous at the origin, reflecting fixed costs of participation. Allowing for general distributions of work opportunity costs and productivity and for income effects, we characterize optimal, incentive-compatible tax schedules. We then give sufficient conditions for society to desire redistribution. When these conditions hold, upward distortions of the financial incentives to work can only occur for low-skilled workers. Such upwards distortions are indeed always present when the fixed participation costs are pecuniary.     

Optimal grouping of commodities for indirect taxation

Indirect taxes contribute to a sizeable part of government revenues around the world. Typically there are few different tax rates, and the goods are partitioned into classes associated with each rate. The present paper studies how to group the goods in these few classes. We take as given the number of tax rates and study the optimal aggregation (or classification) of commodities of the fiscal authority in a second best setup. The results are illustrated on data from the United Kingdom.     

Optimal redistributive taxation with both extensive and intensive responses

We study optimal income taxation when labor supply reacts along the intensive and extensive margins. Individuals are heterogeneous across two unobserved dimensions: their skill and disutility of participation. We develop a new method to analytically derive conditions under which optimal marginal tax rates are non-negative everywhere. It is typically optimal to provide a distinct level of transfer to the non-employed and to workers with negligible earnings. Numerical simulations illustrate these properties for the US. We also apply our method to sign output distortions in other adverse selection frameworks with random participation, namely the monopoly nonlinear pricing and the regulatory monopoly problems.     

Foreign ownership and corporate income taxation: An empirical evaluation

Foreign ownership allows countries to effectively export part of their corporate tax burden. Hence, countries with high foreign ownership are expected to impose relatively high corporate taxes. The findings of this paper suggest that there indeed is an economically significant positive relationship between foreign ownership and tax burdens in Europe. Already significant foreign ownership levels in Europe offer an explanation for the absence of a ‘race to the bottom’ in corporate tax levels.     

Optimal environmental taxation and enforcement policy

We study the optimal environmental taxation and enforcement policy when (i) the regulator does not know the firms’ abatement costs, (ii) penalties for tax evasion are limited, and (iii) monitoring of pollution is costly. We show that the threat of being audited alter the usual firms’ incentives to over-estimate their abatement costs. In particular, depending on the firms’ abatement costs, the optimal policy may involve over or under-deterrence compared to the full information outcome. We then investigate the properties of a pollution standard. We show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered.     

Risky human capital and deferred capital income taxation

We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation. In this setting, we demonstrate the optimality of (a) a human capital premium, i.e., an excess return on human capital relative to physical capital, (b) a large intertemporal wedge early in the life-cycle, and (c) a non-zero intratemporal wedge even at the top of the skill distribution at all dates except the last date in the life-cycle. The main implication for the structure of optimal linear capital taxes is the necessity of deferred taxation of physical capital. The average marginal tax rate on physical capital held in every period is zero in present value. However, expected capital tax payments do not equal zero in every period. Necessarily, agents face negative expected capital tax payments early in the life-cycle and positive expected capital tax payments late in the life-cycle.     

Optimal taxation with endogenously incomplete debt markets

Empirical analyses of labor tax and public debt processes provide prima facie evidence for imperfect government insurance. This paper considers a model in which the government's inability to commit to future policies or to report truthfully its spending needs renders government debt markets endogenously incomplete. A method for solving for optimal fiscal policy under these constraints is developed. Such policy is found to be intermediate between that implied by the complete insurance (Ramsey) model and a model with exogenously incomplete debt markets. In contrast to optimal Ramsey policy, optimal policy in this model is consistent with a variety of stylized fiscal policy facts such as the high persistence of labor tax rates and debt levels and the positive covariance between government spending and the value of government debt sales.     

Voting over income taxation

A major problem of the positive theory of income taxation is to explain why statutory income tax schedules in practice are marginal-rate progressive. While it is commonly believed that this is but a simple consequence of the fact that the number of relatively poor voters exceeds that of richer voters in general, putting this contention in a voting equilibrium context is not a trivial task. We do this here in the context of nonlinear taxation and attempt to provide a formal argument in support of this heuristic claim. We first establish the existence of mixed strategy equilibria and identify certain cases in which marginal-rate progressive taxes are chosen almost surely by the political parties. Unfortunately, we also find that if the tax policy space is not artificially constrained, the support of at least one equilibrium cannot be contained within the set of marginal-rate progressive taxes.     

On the optimality of optimal income taxation

The Mirrleesian model of income taxation restricts attention to simple allocation mechanism with no strategic interdependence, i.e., the optimal labor supply of any one individual does not depend on the labor supply of others. It has been argued by Piketty (2009) [12] that this restriction is substantial because more sophisticated mechanisms can reach first-best allocations that are out of reach with simple mechanisms. In this paper, we assess the validity of Piketty?s critique in an independent private values model. As a main result, we show that the optimal sophisticated mechanism is a simple mechanism, or, equivalently, a Mirrleesian income tax system.     

Dynamic inconsistency and non-preferential taxation of foreign capital

When capital is sunk after it is invested, a host government facing heterogeneous foreign investors has a strong incentive to reduce preferential taxes over time in order to attract less eager investors while fully expropriating past investors. This induces investors to wait rather than invest in the initial period, and leads to loss of tax revenue. This dynamic inconsistency problem is resolved if the host government commits to non-preferential taxation in each period even if it does not commit to future tax rates.     

Optimal income taxation with tax avoidance

We determine the optimal income tax schedule when individuals have the possibility of avoiding paying taxes. Considering a convex concealment cost function, we find that a subset of individuals, located in the interior of the income distribution, should be allowed to avoid taxes, provided that the marginal cost of avoiding the first euro is sufficiently small. This contrasts with the results of Grochulski who shows that, using a subadditive cost function, all individuals should report their true income. We also provide a characterization of the optimal income tax curve.     

Optimal nonlinear income taxation with learning-by-doing

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates generally no longer apply. In particular, if the government cannot commit and each consumer's skill-type is revealed, it is optimal to distort the high-skill type's labour supply downwards through a positive marginal tax rate to relax an incentive-compatibility constraint. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on both labour supply and wages.     

Social security, retirement age and optimal income taxation

It is often argued that implicit taxation on continued activity of elderly workers is responsible for the widely observed trend towards early retirement. In a world of laissez-faire or of first-best efficiency, there would be no such implicit taxation. The point of this paper is that, when first-best redistributive instruments are not available, because some variables are not observable, the optimal policy does imply a distortion of the retirement decision. Consequently, the inducement of early retirement may be part of the optimal tax-transfer policy. We consider a model in which individuals differ in their productivity and their capacity to work long and choose both their weekly labor supply and their age of retirement. We characterize the optimal non-linear tax-transfer that maximizes a utilitarian welfare function when weekly earnings and the length of active life are observable while individuals' productivity and health status are not observable.     

Optimal top marginal tax rates under income splitting for couples

This paper provides formulas for optimal top marginal tax rates when couples are taxed according to income splitting between spouses, consumption is taxed, and the skill distribution is unbounded. Optimal top marginal income tax rates are computed for Germany using a dataset that includes the tax returns of all German top taxpayers. We find that the optimal top marginal tax rate converges to about 2/3 and convergence obtains at income levels that are substantially higher than those currently subject to the actual top tax rate.     

Optimal taxation of car ownership, car use and public transport: Insights derived from a discrete choice numerical optimization model

We formulated and numerically evaluated a model of car ownership, car use and public transport use for peak and off-peak hours of the day. The model was used to study the optimal tax structure for passenger transport in Belgium, with special emphasis on the optimal tax treatment of diesel versus gasoline cars. We obtained a number of interesting results. First, if the government can set all fixed and variable transport taxes optimally, the higher marginal external cost of diesel use implies that the optimal tax per kilometre for the use of a diesel car is higher than for the use of a gasoline car. Moreover, high congestion implies that the taxes on car use in the peak period are more than twice their current levels. However, the optimal tax on ownership of a diesel car is some 200€ below its current level. Second, if the government uses kilometre taxes that do not differentiate between fuel types, the optimal ownership tax on a diesel car is twice as high as the tax on a gasoline car. Furthermore, if political constraints restrict user taxes to their current levels, we find that optimal ownership taxes on diesel cars double, whereas those on gasoline cars rise by 30%. Finally, subsidies to public transport are found to be optimal as long as variable car taxes are not differentiated between periods.     

Optimal linear income taxation with partial information

This letter presents a preliminary analysis of a tax problem whereby the tax function can depend not only on income but also on variables which are correlated with ‘earning ability’ and are known to the government. Our main result suggests that the tax system improved through increased use of such variables, and the optimal tax rate becomes larger.