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.     

On the optimal income taxation and educational decisions

In this paper we consider three different ways of incorporating individuals' educational choices into the design of optimal income tax policy. In one variant of the model (case 2), where an individual chooses his education before knowing his ability and after that education makes his labour supply decisions on the basis of known ability, it is shown that qualitative features of the optimal income tax schedule are not similar to those of the standard optimal income tax model. The marginal tax rate is generally not zero at the endpoints of distribution but is most likely negative. Using numerical methods, some interesting features quite different from earlier numerical results are revealed, especially in the second case. For example, the marginal tax rate is non-decreasing in income for a substantial income range. In addition, our calculations support neither the traditional views on the egalitarian nature of equal education nor its disadvantageous consequences in the perfect utilitarian society.     

On the undesirability of commodity taxation even when income taxation is not optimal

An important result due to Atkinson and Stiglitz (1976) [Atkinson, A.B., Stiglitz, J.E., 1976. The design of tax structure: Direct versus indirect taxation. Journal of Public Economics 6, 55–75.] is that differential commodity taxation is not optimal in the presence of an optimal nonlinear income tax (given weak separability of utility between labor and all consumption goods). This article demonstrates that this conclusion holds regardless of whether the income tax is optimal. In particular, given any commodity tax and income tax system, differential commodity taxation can be eliminated in a manner that results in a Pareto improvement. Also, differential commodity taxation can be proportionally reduced so as to generate a Pareto improvement. In addition, for commodity tax reforms that neither eliminate nor proportionally reduce differential taxation, a simple efficiency condition is offered for determining whether a Pareto improvement is possible.     

Public health insurance and optimal income taxation

If individuals differ not only in their inherent capacity to earn income, but also in the probability that they will fall ill, can subsidized public health insurance be justified on the grounds that it serves as an efficient tool to redistribute welfare? This question is analyzed in a model where the social welfare function is a weighted average of individual expected utilities, and where taxation is by a linear income tax. The answer is ‘yes’, except in certain special cases.     

A contribution to the theory of optimal utilitarian income taxation

The paper provides a new formulation of the Mirrlees–Seade theorem on the positivity of the optimal marginal income tax, under weaker assumptions and in a more general model. The formulation of the theorem is independent of whether the model involves finitely many types or a continuous type distribution. The formal argument makes the underlying logic transparent, relating the mathematics to the economics and showing precisely how each assumption enters the analysis.     

The optimal taxation of risky capital income: An elasticity rule

Should risky capital income be taxed like safe income or should tax rates be differentiated? The question is analyzed in a 2-assets model of portfolio choice. Flat tax rates are chosen in order to maximize the investor's expected utility from terminal wealth subject to an expected tax revenue constraint. If lump-sum taxes are not available, optimal tax rates are characterized by an elasticity rule: The relative change in the risk remuneration should be equal to the inverse of the product of two elasticities. One is the output elasticity of capital. The other is the demand elasticity for risky investments with respect to a revenue preserving tax variation.     

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.     

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.     

On optimal redistributive capital taxation

This paper addresses conflicting results regarding the optimal taxation of capital income. Judd proves that in a steady state, there should be no taxation of capital income. Lansing studies a logarithmic example of one of Judd's models and finds that the optimal steady‐state tax on capital income is not always zero—it is positive in some specifications and negative in some others. There appears to be a contradiction. However, I show that Lansing derives his result by relaxing the convergence hypotheses of Judd's theorem. With less restrictive hypotheses, a wider range of primitives (parameter values, initial condition, etc.) satisfy the hypotheses and because each specification of primitives generates its own optimal time path(s) for the model's variables, it follows that a wider range of time paths with a wider range of steady‐state properties is possible. This raises a question. What happens if the convergence hypotheses are weakened further so that they are satisfied by a wider yet range of primitives? I find that at any interior steady state for the model's optimal tax equilibrium, either the capital tax is zero or else the elasticity of marginal utility is unitary which is satisfied identically in Lansing's log example. In effect, Lansing's example illustrates the only way in which an interior steady state can violate the zero tax result.     

Public investment criteria under optimal nonlinear income taxation without commitment

In this study, we highlight that the incredibility of the government's commitment to a certain tax policy is a determinant of production inefficiency. We show that if the government cannot commit to a certain tax policy and if the types of taxpayers are completely separated, then the production efficiency theorem could be violated in an optimal solution. In this case, an incremental unit of public or private capital affects taxpayers' labor supply through wage rates. In a situation where public capital is more (less) complementary to labor than private capital, public investment tightens (relaxes) the incentive compatibility constraint more than private investment.     

Wage endogeneity,tax evasion,and optimal nonlinear income taxation

This paper studies the interaction between tax evasion and wage endogeneity within a Mirrleesian optimal tax framework. It characterizes the optimal marginal income tax rates on the skilled and the unskilled workers and the optimal amount of resources to be spent on deterring tax evasion. It shows that tax evasion weakens the incentives for the government to manipulate the marginal tax rates for the purpose of exploiting general equilibrium effects on wages. Moreover, the extent of this depends on the curvature of the evasion cost function. It also argues that marginal income tax rates are likely to be higher when the government attempts to deter evasion.     

On the optimal taxation of two person households

This paper generalises the optimal commodity tax formulae for households containing one person to cover the empirically relevant case of two person households. We provide an appropriate framework for the empirical estimation of the optimal tax structure and argue that this may be largely determined by female labour supply behaviour.     

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.     

A reconciliation of recent results in optimal taxation theory

The recent papers by Guesnerie and Diewert on tax reforms are interpreted as contributions to the characterization of second-best optima. This paper demonstrates that when it is possible to achieve any feasible direction of change in supplies by a differential change in producer prices, there are unique producer support prices. Under these circumstances, the apparent differences between Guesnerie and Diewert are reconciled. Optimality conditions with nonunique support prices are also considered.     

Subjective well‐being,consumption comparisons,and optimal income taxation

We introduce reference consumption into the standard utility function from optimal tax analysis. Individuals compare their consumption “narrowly” with those of the same productivity, or “broadly” with the average consumption across society. In both narrow and broad equilibria reference consumption is an increasing function of the tax parameters, so generating new theoretical results. Individual well‐being decreases with the net wage (net‐of‐tax) rate for low productivity workers under narrow (broad) comparisons, thus adjusting redistributive taxation considerations. Further, in both cases reference consumption distorts labor supply away from the social optimum level, giving a distortion‐correcting role for taxation.     

Exchange rates in the short run: Some further results

This note extends our earlier results [published in this Journal. Vol. 10 (1977)] on the dollar DM exchange rate to the 1977–78 period. The original equation estimated on 1971–76 data overpredicts the dollar value of the DM during most of 1978. Thus the rise of the DM in the second half of 1978 was consistent with the ‘fundamentals’ equation. We also show that a net foriegn liability position may destabilize the foreign exchange market and that this may have been empirically significant for the dollar DM rate in 1973–74.     

A note on optimal income taxation,public goods provision and robust mechanism design

This paper extends the model of optimal income taxation due to Mirrlees (Mirrlees, J., 1971. An exploration in the theory of optimum income taxation. Review of Economic Studies 38, 175–208) and includes private information on public goods preferences. A mechanism design approach is used to establish the following result: If policies are required to be robustly implementable in the sense of Bergemann and Morris (Bergemann, D., Morris, S., 2005. Robust mechanism design. Econometrica 73, 1771–1813), then the optimality conditions in the extended model with uncertainty about tax and expenditure policies are the same as in the standard model of optimal income taxation. The paper provides a foundation for a widely-used assumption in public finance, namely that individuals optimize their behavior subject to a predetermined and commonly known tax system.     

Majority voting on tax parameters: Some further results

Earlier analysis of properties of tax functions chosen by majority rule is extended to include more general characterization of individual preferences. Outcomes when preferences are not single-peaked are discussed in some detail.