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.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
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
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Oswald, Andrew J., 1983. "Altruism, jealousy and the theory of optimal non-linear taxation," Journal of Public Economics, Elsevier, vol. 20(1), pages 77-87, February.
- Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
- Tuomala, Matti, 1990. "Optimal Income Tax and Redistribution," OUP Catalogue, Oxford University Press, number 9780198286059.
- Rablen, Matthew D., 2010. "Performance targets, effort and risk-taking," Journal of Economic Psychology, Elsevier, vol. 31(4), pages 687-697, August.
- Kanbur, Ravi & Pirttila, Jukka & Tuomala, Matti, 2004.
"Non-Welfarist Optimal Taxation And Behavioral Public Economics,"
127150, Cornell University, Department of Applied Economics and Management.
- Ravi Kanbur & Jukka Pirttilä & Matti Tuomala, 2006. "Non-Welfarist Optimal Taxation And Behavioural Public Economics," Journal of Economic Surveys, Wiley Blackwell, vol. 20(5), pages 849-868, December.
- Ravi Kanbur & Jukka Pirttilä & Matti Tuomala, 2004. "Non-Welfarist Optimal Taxation and Behavioral Public Economics," CESifo Working Paper Series 1291, CESifo Group Munich.
- Xianhua Dai, 2011. "Optimal Taxation under Income Uncertainty," Annals of Economics and Finance, Society for AEF, vol. 12(1), pages 121-138, May.
- Marcelo Arbex & Enlinson Mattos, 2010. "Poverty and the Optimal General Income Tax-cum-Audit Policy," Working Papers 02-2010, Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto.
- Amedeo Piolatto & Gwenola Trotin, 2011.
"Optimal tax enforcement under prospect theory,"
2011/29, Institut d'Economia de Barcelona (IEB).
- Amit Kothiyal & Vitalie Spinu & Peter Wakker, 2011. "Prospect theory for continuous distributions: A preference foundation," Journal of Risk and Uncertainty, Springer, vol. 42(3), pages 195-210, June.
- Robin Boadway & Motohiro Sato, 2011. "Optimal Income Taxation with Uncertain Earnings: A Synthesis," CESifo Working Paper Series 3654, CESifo Group Munich.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (AgEcon Search).
If references are entirely missing, you can add them using this form.