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A Characteristics Approach to Optimal Taxation: Line Drawing and Tax‐Driven Product Innovation

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  • Christian Gillitzer
  • Henrik Jacobsen Kleven
  • Joel Slemrod

Abstract

Real‐world tax legislation assigns goods to different categories of tax rates on the basis of observable characteristics, allowing the tax system to handle a constantly evolving set of available goods. We recast the theory of optimal taxation in the language of characteristics, and we show how to optimally draw lines that delineate tax‐rate regimes. Such lines are associated with notches in tax liability as a function of characteristics, creating incentives to introduce goods with new combinations of characteristics in order to reduce tax liability. With a restricted set of tax instruments, such notches are in general part of the second‐best optimal tax system.

Suggested Citation

  • Christian Gillitzer & Henrik Jacobsen Kleven & Joel Slemrod, 2017. "A Characteristics Approach to Optimal Taxation: Line Drawing and Tax‐Driven Product Innovation," Scandinavian Journal of Economics, Wiley Blackwell, vol. 119(2), pages 240-267, April.
  • Handle: RePEc:bla:scandj:v:119:y:2017:i:2:p:240-267
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    File URL: https://doi.org/10.1111/sjoe.12174
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    Cited by:

    1. Traxler, Christian & Westermaier, Franz G. & Wohlschlegel, Ansgar, 2018. "Bunching on the Autobahn? Speeding responses to a ‘notched’ penalty scheme," Journal of Public Economics, Elsevier, vol. 157(C), pages 78-94.

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    JEL classification:

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

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