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Explaining Taxes at the Upper Tail of the Income Distribution: The Role of Utility Interdependence

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  • Daniel Sámano

Abstract

Optimal tax theory has difficulty rationalizing high marginal tax rates at the upper end of the income distribution. In this paper, I construct a model of optimal income taxation in which agents’ preferences are interdependent. I derive a simple expression for optimal taxes that accommodates consumption externalities within Mirrlees (1971) frame-work. Using this expression, I conduct a positive analysis of taxation: assuming that observed taxes are optimal, I derive analytic expressions for i) a parameter that measures the degree of agents’ utility interdependence and ii) a function that quantifies the consumption externality agents of different income impose to society. Using these expressions, I rationalize income taxes in the United States and the United Kingdom for the 1995-2004 period. I show that only a moderate amount of utility interdependence is sufficient for this. My estimations indicate that the progressivity of tax schedules may be driven by corrective considerations.

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Paper provided by Banco de México in its series Working Papers with number 2009-16.

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Date of creation: Dec 2009
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Handle: RePEc:bdm:wpaper:2009-16

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Keywords: Optimal non-linear taxation; relative consumption; rationalization.;

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