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Pareto Efficient Income Taxation with Stochastic Abilities

  • Marco Battaglini
  • Stephen Coate

This paper studies Pareto efficient income taxation in an economy with infinitely-lived individuals whose income generating abilities evolve according to a two-state Markov process. The study yields two main results. First, when individuals are risk neutral, the fraction of individuals who face a positive marginal income tax rate is always positive but converges to zero. Moreover, the tax rate these individuals face also goes to zero. Second, Pareto efficient income tax systems can be time-consistent even when the degree of correlation in ability types is large.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10119.

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Date of creation: Nov 2003
Date of revision:
Publication status: published as Battaglini, Marco & Coate, Stephen, 2008. "Pareto efficient income taxation with stochastic abilities," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 844-868, April.
Handle: RePEc:nbr:nberwo:10119
Note: PE
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  1. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
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  10. Brito, Dagobert L. & Hamilton, Jonathan H. & Slutsky, Steven M. & Stiglitz, Joseph E., 1991. "Dynamic optimal income taxation with government commitment," Journal of Public Economics, Elsevier, vol. 44(1), pages 15-35, February.
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  17. Roberts, Kevin, 1984. "The Theoretical Limits of Redistribution," Review of Economic Studies, Wiley Blackwell, vol. 51(2), pages 177-95, April.
  18. Stokey, Nancy L, 1989. "Reputation and Time Consistency," American Economic Review, American Economic Association, vol. 79(2), pages 134-39, May.
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