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Optimal Dynamic Nonlinear Income Taxes with No Commitment

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  • Berliant, Marcus
  • Ledyard, John

Abstract

We wish to study optimal dynamic nonlinear income taxes. Do real world taxes share some of their features? What policy prescriptions can be made? We study a two period model, where the consumers and government each have separate budget constraints in the two periods, so income cannot be transferred between periods. Labor supply in both periods is chosen by the consumers. The government has memory, so taxes in the first period are a function of first period labor income, whereas taxes in the second period are a function of both first and second period labor income. The government cannot commit to future taxes. Time consistency is thus imposed as a requirement. The main results of the paper show that time consistent incentive compatible two period taxes involve separation of types in the first period and a differentiated lump sum tax in the second period, provided that the discount rate is high or utility is separable between labor and consumption. In the natural extension of the Diamond (1998) model with quasi-linear utility functions to two periods, an equivalence of dynamic and static optimal taxes is demonstrated, and a necessary condition for the top marginal tax rate on first period income is found.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 31749.

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Date of creation: 21 Jun 2011
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Handle: RePEc:pra:mprapa:31749

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Keywords: Optimal Income Taxation; Time Consistency; Incentive Compatibility; Sequential Information Revelation; Optimal Dynamic Taxation;

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  1. Marco Battaglini & Stephen Coate, 2003. "Pareto Efficient Income Taxation with Stochastic Abilities," NBER Working Papers 10119, National Bureau of Economic Research, Inc.
  2. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  3. Battaglini, Marco, 2005. "Optimality and Renegotiation in Dynamic Contracting," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5014, C.E.P.R. Discussion Papers.
  4. Torsten Persson & Guido Tabellini, 2002. "Political Economics: Explaining Economic Policy," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262661314, December.
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  6. Narayana R. Kocherlakota, 2005. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Econometrica, Econometric Society, Econometric Society, vol. 73(5), pages 1587-1621, 09.
  7. Adriano Rampini & Alberto Bisin, 2005. "Markets as Beneficial Constraints on the Government," 2005 Meeting Papers, Society for Economic Dynamics 325, Society for Economic Dynamics.
  8. Marek Kapicka, 2006. "Optimal Income Taxation with Human Capital Accumulation and Limited Record Keeping," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 612-639, October.
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  18. Berliant, Marcus & Page, Frank H, Jr, 2001. "Income Taxes and the Provision of Public Goods: Existence of an Optimum," Econometrica, Econometric Society, Econometric Society, vol. 69(3), pages 771-84, May.
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Cited by:
  1. Stephen Coate & Marco Battaglini, 2004. "Pareto Efficient Income Taxation with Stochastic Abilities," 2004 Meeting Papers, Society for Economic Dynamics 140, Society for Economic Dynamics.
  2. Jang‐Ting Guo & Alan Krause, 2011. "Optimal Nonlinear Income Taxation with Habit Formation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 13(3), pages 463-480, 06.
  3. Krause, Alan, 2009. "Optimal nonlinear income taxation with learning-by-doing," Journal of Public Economics, Elsevier, Elsevier, vol. 93(9-10), pages 1098-1110, October.
  4. Jean-Marie Lozachmeur, 2006. "Disability insurance and optimal income taxation," International Tax and Public Finance, Springer, Springer, vol. 13(6), pages 717-732, November.
  5. Jenny Simon, 2014. "The Role of Imperfect Financial Markets for Social Redistribution," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, Ifo Institute for Economic Research at the University of Munich, vol. 11(4), pages 32-37, 01.
  6. Berliant, Marcus & Fujishima, Shota, 2013. "Optimal Dynamic Nonlinear Income Taxes: Facing an Uncertain Future with a Sluggish Government," MPRA Paper 47064, University Library of Munich, Germany.
  7. Jenny Simon, 2014. "Imperfect Financial Markets as a Commitment Device for the Government," CESifo Working Paper Series 4902, CESifo Group Munich.
  8. Craig Brett, 2012. "The effects of population aging on optimal redistributive taxes in an overlapping generations model," International Tax and Public Finance, Springer, Springer, vol. 19(6), pages 777-799, December.
  9. Craig Brett & John Weymark, 2008. "Optimal Nonlinear Taxation of Income and Savings without Commitment," Vanderbilt University Department of Economics Working Papers 0805, Vanderbilt University Department of Economics.
  10. Salvador Ball & Amadéo Spadaro, 2006. "Optimal nonlinear labor income taxation in dynamic economies," PSE Working Papers halshs-00590555, HAL.
  11. Craig Brett & John A. Weymark, 2005. "Optimal Nonlinear Taxation of Income and Savings in a Two Class Economy," Vanderbilt University Department of Economics Working Papers 0525, Vanderbilt University Department of Economics.
  12. Adriano Rampini & Alberto Bisin, 2005. "Markets as Beneficial Constraints on the Government," 2005 Meeting Papers, Society for Economic Dynamics 325, Society for Economic Dynamics.
  13. Jang-Ting Guo & Alan Krause, . "Dynamic Nonlinear Income Taxation with Quasi-Hyperbolic Discounting and No Commitment," Discussion Papers, Department of Economics, University of York 11/16, Department of Economics, University of York.
  14. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  15. Christopher Sleet & Sevin Yeltekin, 2006. "Credibility and endogenous societal discounting," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(3), pages 410-437, July.
  16. Alan Krause, 2008. "Optimal Nonlinear Income Taxation with Learning-by-Doing," Discussion Papers, Department of Economics, University of York 08/08, Department of Economics, University of York.

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