Choosing The Tax Rate in a Linear Income Tax Structure: An Introduction
This paper provides an introduction to modelling the choice of linear income tax rate in both majority voting and social welfare maximising contexts. Although the basic problem in each case — of finding the most preferred tax for the median voter and the welfare maximising tax for an independent judge or decision-maker — can be simply stated, it is usually not possible to obtain explicit solutions even for simple assumptions about preferences and population heterogeneity. The present paper instead gives special attention to a formulation of the required conditions in terms of easily interpreted magnitudes, the elasticity of average earnings with respect to the tax rate and a measure of inequality. The inequality measure takes the same basic form in each model (depending either on median earnings or a weighted average of earnings, where the weights depend on value judgements regarding inequality aversion. The approach enables the comparative static effects of a range of parameter changes to be considered. The results are reinforced using numerical examples based on the constant elasticity of substitution utility function.
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