Moral Hazard, Income Taxation, And Prospect Theory
AbstractThe standard theory of optimal income taxation under uncertainty has been developed under the assumption that individuals maximize expected utility. However, prospect theory has now been established as an alternative model of individual behaviour, with empirical support. This paper explores the theory of optimal income taxation under uncertainty when individuals behave according to the tenets of prospect theory. It is seen that many of the standard results are either overturned, or modified in interesting ways. The validity of the First Order Approach requires new conditions that are developed in the paper. And when these conditions are valid, it is shown that optimal marginal tax rates on low incomes will tend to be lower under prospect theory than under expected utility theory.
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Bibliographic InfoPaper provided by Cornell University, Department of Applied Economics and Management in its series Working Papers with number 127136.
Date of creation: Apr 2004
Date of revision:
redistributive taxation; income uncertainty; moral hazard; prospect theory; loss aversion; Public Economics; D81; H21.;
Other versions of this item:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
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