Optimal Income Taxation with a Stationarity Constraint in a Dynamic Stochastic Economy

Berliant, Marcus and Fujishima, Shota (2015): Optimal Income Taxation with a Stationarity Constraint in a Dynamic Stochastic Economy.

Abstract

We consider the optimal nonlinear income taxation problem in a dynamic, stochastic environment when the government cannot change the tax rule as uncertainty resolves. Due to such a stationarity constraint, our taxation problem is reduced to a static one over an expanded type space. We strengthen the argument in the static model that the zero top marginal tax rate result is of little practical importance because it is actually relevant only when the top earner in the initial period receives the highest shock in every subsequent period. Under a general stochastic structure such that the support of types moves over time, all people’s allocations are almost surely distorted in any period.

• Item Type: MPRA Paper
• Language: English
• Keywords: Optimal income taxation; New dynamic public finance
• Subjects: H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency ; Optimal Taxation

References

Albanesi, S. and C. Sleet. (2006), ”Dynamic optimal taxation with private information,” Review of Economic Studies, 73, 1-30.

Battaglini, M. and S. Coate. (2008), ”Pareto efficient income taxation with stochastic abilities,” Journal of Public Economics, 92, 844-868.

Berliant, M. and J. Ledyard. (2014), ”Optimal dynamic nonlinear income taxes with no commitment,” Journal of Public Economic Theory, 16, 196-221.

Berliant, M. and F. H. Page. (2001), ”Income taxes and the provision of public goods: existence of an optimum,” Econometrica, 69, 771-784.

Diamand, P. (1998), ”Optimal income taxation: an example with a U-shaped pattern of optimal marginal tax rate,” American Economic Review, 88, 83-95.

Diamond, P. and E. Saez. (2011), ”The case for a progressive tax: From basic research to policy recommendation,” Journal of Economic Perspectives, 25, 165- 190.

Farhi, E. and I. Werning. (2013), ”Insurance and taxation over the life cycle,” Review of Economic Studies, 80, 596-635.

Gaube, T. (2010), ”Taxation of annual income as a commitment device,” Unpublished manuscript.

Golosov, M., A. Shourideh., M. Troshkin., and A. Tsyvinski (2013), ”Optimal pension systems with simple instruments,” American Economic Review: Papers & Proceedings, 103, 502-507.

Hammond, P. (1979), ”Straightforward individual incentive compatibility in large economies,” Review of Economic Studies, 46, 263-282.

Hellwig, M. F. (2007), ”A contribution to the theory of optimal utilitarian income taxation,” Journal of Public Economics, 91, 1449-1477.

Judd, K. L. (1985), ”The law of large numbers with a continuum of i.i.d. random variables,” Journal of Economic Theory, 35, 19-25.

Kapicka, M. (2006), ”Optimal income taxation with human capital accumulation and limited record keeping,” Review of Economic Dynamics, 9, 612-639.

Kocherlakota, N. (2010), The New Dynamic Public Finance, Princeton University Press.

Kocherlakota, N. (2005), ”Zero expected wealth taxes: A Mirrlees approach to dynamic optimal taxation,” Econometrica, 73, 1587-1621.

Kocherlakota, N. (2004), ”Wedges and taxes,” American Economic Review, 94, 109-113.

Mirrlees, J. A. (1971), ”An exploration in the theory of optimal income taxation,” Review of Economic Studies, 38, 175-208.

Seade, J. K. (1982), ”On the sign of the optimum marginal income tax,” Review of Economic Studies, 49, 637-643.

Storesletten, K., C. I. Telmer., and A. Yaron. (2004), ”Cyclical dynamics in idiosyncratic labor market risk,” Journal of Political Economy, 112, 695-717.

Sun, Y. (2006), ”The exact law of large numbers via Fubini extension and characterization of insurable risks,” Journal of Economic Theory, 126, 31-69.

Weinzierl, M. (2011), ”The surprising power of age-dependent taxes,” Review of Economic Studies, 78, 1490-1518.

Weymark, J. A. (1987), ”Comparative static properties of optimal nonlinear income taxes,” Econometrica, 55, 1165-1185.