Optimal Non-Linear Income Taxation for the Alleviation of Income Poverty

There has been much discussion recently of structuring tax and transfer programs to ensure that resources go to the poor, with minimal leaks to the nonpoor. The poor have no incentive to earn income with 100 percent marginal tax rates, but how high or low the marginal rate of taxation should be, and how they should vary with income, is a complex issue - and opinions vary. Social security schemes that withdraw benefits represent an extremely high effective marginal tax rate; other schemes call for relatively low marginal tax rates at the bottom of the income distribution. Which tax-transfer schedule does most to reduce poverty? The issue is one of optimal nonlinear income taxation. The authors show that one of the key theoretical results of the welfarist literature is overturned: if it is desirable for everybody to work, the optimal marginal tax rate on the very poorest individuals is strictly negative. They argue that the nonwelfarist perspective points toward lower marginal tax rates in the lower part of the income distribution than does the welfarist perspective. But numerical simulations suggest that the effect is of limited quantitative significance. Using conventional functional forms and parameter values, optimal marginal tax rates on the poor are in the 60-70 percent range.(This abstract was borrowed from another version of this item.)(This abstract was borrowed from another version of this item.)