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Using Elasticities to Derive Optimal Income Tax Rates

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Emmanuel Saez

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Abstract

This paper derives optimal income tax formulas using compensated and uncompensated elasticities of earnings with respect to tax rates. A simple formula for the high income optimal tax rate is obtained as a function of these elasticities and the thickness of the top tail of the income distribution. In the general non-linear income tax problem, this method using elasticities shows precisely how the different economic effects come into play and which are the key relevant parameters in the optimal income tax formulas of Mirrlees. The optimal non-linear tax rate formulas are expressed in terms of elasticities and the shape of the income distribution. These formulas are implemented numerically using empirical earnings distributions and a range of realistic elasticity parameters.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7628.

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Date of creation: Mar 2000
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Handle: RePEc:nbr:nberwo:7628

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H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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  1. Dixit, Avinash K & Sandmo, Angar, 1977. " Some Simplified Formulae for Optimal Income Taxation," Scandinavian Journal of Economics, Blackwell Publishing, vol. 79(4), pages 417-23.
  2. Sadka, Efraim, 1976. "On Income Distribution, Incentive Effects and Optimal Income Taxation," Review of Economic Studies, Blackwell Publishing, vol. 43(2), pages 261-67, June. [Downloadable!] (restricted)
  3. Richard Blundell, 1992. "Labour supply and taxation: a survey," Fiscal Studies, Institute for Fiscal Studies, vol. 13(3), pages 15-40, January.
  4. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. 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)
  6. Kevin Roberts, 2000. "A Reconsideration of the Optimal Income Tax," Economics Series Working Papers 006, University of Oxford, Department of Economics. [Downloadable!]
  7. Ahmad, Ehtisham & Stern, Nicholas, 1984. "The theory of reform and indian indirect taxes," Journal of Public Economics, Elsevier, vol. 25(3), pages 259-298, December. [Downloadable!] (restricted)
  8. Blundell, Richard & Macurdy, Thomas, 1999. "Labor supply: A review of alternative approaches," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 27, pages 1559-1695 Elsevier. [Downloadable!] (restricted)
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  9. Atkinson, A. B., 1990. "Public economics and the economic public," European Economic Review, Elsevier, vol. 34(2-3), pages 225-248, May. [Downloadable!] (restricted)
  10. 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)
  11. Seade, Jesus, 1982. "On the Sign of the Optimum Marginal Income Tax," Review of Economic Studies, Blackwell Publishing, vol. 49(4), pages 637-43, October. [Downloadable!] (restricted)
  12. Dahlby, Bev, 1998. "Progressive taxation and the social marginal cost of public funds," Journal of Public Economics, Elsevier, vol. 67(1), pages 105-122, January. [Downloadable!] (restricted)
  13. Ballard, Charles L & Fullerton, Don, 1992. "Distortionary Taxes and the Provision of Public Goods," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 117-31, Summer. [Downloadable!] (restricted)
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  14. Diamond, Peter A, 1998. "Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates," American Economic Review, American Economic Association, vol. 88(1), pages 83-95, March. [Downloadable!] (restricted)
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