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Optimal Dynamic Nonlinear Income Taxes with No Commitment

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Author Info

  • Marcus Berliant

    (Washington University in St. Louis)

  • John Ledyard

    (California Institute of Technology)

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, while 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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File URL: http://128.118.178.162/eps/pe/papers/0403/0403004.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Public Economics with number 0403004.

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Length: 28 pages
Date of creation: 19 Mar 2004
Date of revision: 21 Jun 2005
Handle: RePEc:wpa:wuwppe:0403004

Note: Type of Document - pdf; pages: 28
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Web page: http://128.118.178.162

Related research

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

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References

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  1. Benhabib, J. & Rustichini, A., 1996. "Optimal Taxes Without Commitment," Working Papers 96-18, C.V. Starr Center for Applied Economics, New York University.
  2. Stephen Coate & Marco Battaglini, 2004. "Pareto Efficient Income Taxation with Stochastic Abilities," 2004 Meeting Papers 140, Society for Economic Dynamics.
  3. Bisin, Alberto & Rampini, Adriano A., 2006. "Markets as beneficial constraints on the government," Journal of Public Economics, Elsevier, vol. 90(4-5), pages 601-629, May.
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Citations

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Cited by:
  1. Salvador Balle & Amedeo Spadaro, 2006. "Optimal Nonlinear Labor Income Taxation in Dynamic Economies," Working Papers 19, ECINEQ, Society for the Study of Economic Inequality.
  2. Alan Krause, 2008. "Optimal Nonlinear Income Taxation with Learning-by-Doing," Discussion Papers 08/08, Department of Economics, University of York.
  3. 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.
  4. Stephen Coate & Marco Battaglini, 2004. "Pareto Efficient Income Taxation with Stochastic Abilities," 2004 Meeting Papers 140, Society for Economic Dynamics.
  5. Adriano Rampini & Alberto Bisin, 2005. "Markets as Beneficial Constraints on the Government," 2005 Meeting Papers 325, Society for Economic Dynamics.
  6. Brett, Craig, 2008. "The effects of population aging on optimal redistributive taxes in an overlapping generations model," MPRA Paper 8585, University Library of Munich, Germany.
  7. 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.
  8. 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.
  9. Jang-Ting Guo & Alan Krause, . "Dynamic Nonlinear Income Taxation with Quasi-Hyperbolic Discounting and No Commitment," Discussion Papers 11/16, Department of Economics, University of York.
  10. repec:hal:wpaper:halshs-00590555 is not listed on IDEAS
  11. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  12. 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.
  13. Jean-Marie Lozachmeur, 2006. "Disability insurance and optimal income taxation," International Tax and Public Finance, Springer, vol. 13(6), pages 717-732, November.
  14. Krause, Alan, 2009. "Optimal nonlinear income taxation with learning-by-doing," Journal of Public Economics, Elsevier, vol. 93(9-10), pages 1098-1110, October.

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