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The Optimal Two-Bracket Linear Income Tax

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Author Info
Joel Slemrod
Shlomo Yitzhaki
Joram Mayshar

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Abstract

We investigate the optimal rate structure of an income tax system that is constrained to have only two brackets, plus a demogrant. We find that, in a two-class economy, Pareto efficient tax schedules feature at least one marginal tax rate equal to zero, and that the marginal tax rate may be increasing or declining. We next use numerical optimization techniques to study the optimal structure of such a tax system in a multi-person model that is a stylized version of an actual economy. We discover that in all cases the tax rate in the second (higher) bracket is less than the tax rate that applies to the first bracket but that progressivity, in the sense of a uniformly rising average tax rate, generally obtains. Compared to the optimal one-bracket (linear) tax system, both the highest and lowest income individuals are better off, while a middle range of taxpayers is worse off.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3847.

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Date of creation: Sep 1991
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Publication status: published as Journal of Public Economics, Vol. 53, no. 2 (February 1994): 269-290.
Handle: RePEc:nbr:nberwo:3847

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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.:
  1. Sheshinski, Eytan, 1972. "The Optimal Linear Income-Tax," Review of Economic Studies, Blackwell Publishing, vol. 39(3), pages 297-302, July. [Downloadable!] (restricted)
  2. Seade, J. K., 1977. "On the shape of optimal tax schedules," Journal of Public Economics, Elsevier, vol. 7(2), pages 203-235, April. [Downloadable!] (restricted)
  3. Phelps, Edmund S, 1973. "Taxation of Wage Income for Economic Justice," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 331-54, August. [Downloadable!] (restricted)
  4. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Blackwell Publishing, vol. 38(114), pages 175-208, April. [Downloadable!] (restricted)
  5. J. A. Mirrlees, 1976. "Optimal Tax Theory: A Synthesis," Working papers 176, Massachusetts Institute of Technology (MIT), Department of Economics.
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  6. Sheshinski, Eytan, 1989. "Note on the shape of the optimum income tax schedule," Journal of Public Economics, Elsevier, vol. 40(2), pages 201-215, November. [Downloadable!] (restricted)
  7. Yitzhaki, Shlomo, 1982. "A tax programming model," Journal of Public Economics, Elsevier, vol. 19(1), pages 107-120, October. [Downloadable!] (restricted)
  8. Stern, N. H., 1976. "On the specification of models of optimum income taxation," Journal of Public Economics, Elsevier, vol. 6(1-2), pages 123-162. [Downloadable!] (restricted)
  9. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March. [Downloadable!] (restricted)
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(explanations, 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.)

  1. Mihir A. Desai & Dhammika Dharmapala & Winnie Fung, 2005. "Taxation and the Evolution of Aggregate Corporate Ownership Concentration," NBER Working Papers 11469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Lundholm, Michael, 1999. "Comments on Social Insurance and the Optimum Piecewise Linear Income Tax," Research Papers in Economics 1999:8, Stockholm University, Department of Economics. [Downloadable!]
  3. Louis Kaplow, 2006. "Optimal Income Transfers," NBER Working Papers 12284, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. François Bourguignon & Amedeo Spadaro, 2006. "Microsimulation as a Tool for Evaluating Redistribution Policies," Working Papers 20, ECINEQ, Society for the Study of Economic Inequality. [Downloadable!]
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  5. Louis Kaplow, 2003. "Concavity of Utility, Concavity of Welfare, and Redistribution of Income," NBER Working Papers 10005, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Homburg, Stefan, 2002. "The Optimal Income Tax: Restatement and Extensions," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-252, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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  7. Joel Slemrod, 1998. "The Economics of Taxing the Rich," NBER Working Papers 6584, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Alberto Alesina & Philippe Weil, 1992. "Menus of Linear Income Tax Schedules," NBER Working Papers 3968, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Pablo Serra, 1998. "El Sistema Impositivo y su Efecto en el Funcionamiento de la Economía: Una Revisión de la Literatura," Working Papers Central Bank of Chile 39, Central Bank of Chile. [Downloadable!]
  10. Alan J. Auerbach & James R. Hines Jr., 2001. "Taxation and Economic Efficiency," NBER Working Papers 8181, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Kemper W. Moreland, 2004. "The rise or fall of graduated income tax rates," Applied Economics Letters, Taylor and Francis Journals, vol. 11(4), pages 227-229, March. [Downloadable!] (restricted)
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