Optimal Nonlinear Income Taxation for Non-Cooperative Couples

This study examines optimal nonlinear income taxation on non-cooperative couples that under-provide a household public good. In this study, the income tax has the role of improving the under-provision of the household public good in addition to equity consideration and revenue collection. The optimal marginal tax rate is characterized by the well-known Mirrleesian ABC term and new Pigouvian term. The Pigouvian term can be further decomposed by the two parts. The first reflects the effects of improving the under-provision of the household public good, while the second relates to the expansion of the income tax flexibility. The Pigouvian term results in the marginal tax rate on the top earner being positive. Using US wage data, our quantitative analysis shows that the existence of non-cooperative behavior raises the optimal marginal tax rates at any income level. This result suggests that the optimal marginal tax rates derived in previous studies, which disregard noncooperative behavior, may have been lowly estimated.