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Optimal Dynamic Nonlinear Income Taxes with No Commitment

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  • 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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  9. Battaglini, Marco, 2007. "Optimality and renegotiation in dynamic contracting," Games and Economic Behavior, Elsevier, vol. 60(2), pages 213-246, August.
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Citations

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Cited by:
  1. Alan Krause, 2008. "Optimal Nonlinear Income Taxation with Learning-by-Doing," Discussion Papers 08/08, Department of Economics, University of York.
  2. 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.
  3. Craig Brett, 2012. "The effects of population aging on optimal redistributive taxes in an overlapping generations model," International Tax and Public Finance, Springer, vol. 19(6), pages 777-799, December.
  4. Marco Battaglini & Stephen Coate, 2003. "Pareto Efficient Income Taxation with Stochastic Abilities," NBER Working Papers 10119, National Bureau of Economic Research, Inc.
  5. 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.
  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. 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.
  8. Salvador Ball & Amadéo Spadaro, 2006. "Optimal nonlinear labor income taxation in dynamic economies," Working Papers halshs-00590555, HAL.
  9. 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.
  10. Jang-Ting Guo & Alan Krause, 2008. "Optimal Nonlinear Income Taxation with Habit Formation," Working Papers 200810, University of California at Riverside, Department of Economics, revised Aug 2008.
  11. Salvador Balle & Amedeo Spadaro, 2006. "Optimal Nonlinear Labor Income Taxation in Dynamic Economies," Working Papers 19, ECINEQ, Society for the Study of Economic Inequality.
  12. 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.
  13. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  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.
  15. Jean-Marie Lozachmeur, 2006. "Disability insurance and optimal income taxation," International Tax and Public Finance, Springer, vol. 13(6), pages 717-732, November.

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