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Optimal Income Taxation with Composition Effects

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  • Laurence Jacquet
  • Etienne Lehmann

Abstract

We study the optimal nonlinear income tax problem with multidimensional individual characteristics on which taxes cannot be conditioned. We obtain an optimal tax formula that generalizes the standard one by averaging, with specific weights, the sufficient statistics of individuals who earn the same income. Our first main contribution consists in showing that multidimensional heterogeneity brings a new source of endogeneity to the sufficient statistics that we call composition effects. We highlight that composition effects may substantially affect optimal marginal tax rates. Our results put the stress on the need for empirical studies on sufficient statistics for different demographic groups e.g., according to gender, age, ethnicity. As a second main contribution, we show the equivalence between the tax perturbation and mechanism design approaches which bridges the gap between both methods that have, so far, been used separately in the literature.

Suggested Citation

  • Laurence Jacquet & Etienne Lehmann, 2017. "Optimal Income Taxation with Composition Effects," CESifo Working Paper Series 6654, CESifo.
  • Handle: RePEc:ces:ceswps:_6654
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    References listed on IDEAS

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    Cited by:

    1. Dominik Sachs & Aleh Tsyvinski & Nicolas Werquin, 2020. "Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium," Econometrica, Econometric Society, vol. 88(2), pages 469-493, March.
    2. Johannes Hermle & Andreas Peichl, 2018. "Jointly Optimal Taxes for Different Types of Income," CESifo Working Paper Series 7248, CESifo.
    3. Gauthier, Stéphane & Henriet, Fanny, 2018. "Commodity taxes and taste heterogeneity," European Economic Review, Elsevier, vol. 101(C), pages 284-296.

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    Keywords

    optimal taxation; multidimensional screening problems; tax perturbation; allocation perturbation; sufficient statistics;
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