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Pareto Efficient Income Taxation with Stochastic Abilities

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  • Marco Battaglini
  • Stephen Coate

Abstract

This paper studies Pareto efficient income taxation in an economy with infinitely-lived individuals whose income generating abilities evolve according to a two-state Markov process. The study yields two main results. First, when individuals are risk neutral, the fraction of individuals who face a positive marginal income tax rate is always positive but converges to zero. Moreover, the tax rate these individuals face also goes to zero. Second, Pareto efficient income tax systems can be time-consistent even when the degree of correlation in ability types is large.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10119.

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Date of creation: Nov 2003
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Publication status: published as Battaglini, Marco & Coate, Stephen, 2008. "Pareto efficient income taxation with stochastic abilities," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 844-868, April.
Handle: RePEc:nbr:nberwo:10119

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  1. Brito, Dagobert L. & Hamilton, Jonathan H. & Slutsky, Steven M. & Stiglitz, Joseph E., 1991. "Dynamic optimal income taxation with government commitment," Journal of Public Economics, Elsevier, vol. 44(1), pages 15-35, February.
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  13. Battaglini, Marco, 2005. "Optimality and Renegotiation in Dynamic Contracting," CEPR Discussion Papers 5014, C.E.P.R. Discussion Papers.
  14. Stokey, Nancy L, 1989. "Reputation and Time Consistency," American Economic Review, American Economic Association, vol. 79(2), pages 134-39, May.
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  16. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
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