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The Optimal Two-Bracket Linear Income Tax

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  • Joel Slemrod
  • Shlomo Yitzhaki
  • Joram Mayshar

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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Bibliographic Info

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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  1. Joseph E. Stiglitz, 1987. "Pareto Efficient and Optimal Taxation and the New New Welfare Economics," NBER Working Papers 2189, National Bureau of Economic Research, Inc.
  2. Yitzhaki, Shlomo, 1982. "A tax programming model," Journal of Public Economics, Elsevier, vol. 19(1), pages 107-120, October.
  3. 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.
  4. Seade, J. K., 1977. "On the shape of optimal tax schedules," Journal of Public Economics, Elsevier, vol. 7(2), pages 203-235, April.
  5. Sheshinski, Eytan, 1972. "The Optimal Linear Income-Tax," Review of Economic Studies, Wiley Blackwell, vol. 39(3), pages 297-302, July.
  6. J. A. Mirrlees, 1976. "Optimal Tax Theory: A Synthesis," Working papers 176, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Joseph E. Stiglitz, 1981. "Self-Selection and Pareto Efficient Taxation," NBER Working Papers 0632, National Bureau of Economic Research, Inc.
  8. 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.
  9. Sadka, Efraim, 1976. "On Income Distribution, Incentive Effects and Optimal Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 261-67, June.
  10. 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.
  11. 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.
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