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Pareto Efficient Income Taxation with Stochastic Abilities

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  • Marco Battaglini
  • Stephen Coate

Abstract

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.

Suggested Citation

  • Marco Battaglini & Stephen Coate, 2003. "Pareto Efficient Income Taxation with Stochastic Abilities," NBER Working Papers 10119, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10119
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    JEL classification:

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

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