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Department of Economics, Norwegian School of Economics (NHH) Discussion Paper Series in Economics, Department of Economics, Norwegian School of Economics (NHH)

No 7/2010:
Optimal Redistributive Taxation with both Extensive and Intensive Responses.

Laurence Jacquet (), Etienne Lehmann () and Bruno Van der Linden ()

Abstract: This paper characterizes the optimal income taxation when individuals respond along both the intensive and extensive margins. Individuals are heterogeneous in two dimensions: their skills and their disutility of participation. Preferences over consumption and work effort can differ with the skill level, only the Spence-Mirrlees condition being imposed. We derive an optimal tax formula thanks to a tax perturbation approach. This formula generalizes previous results by allowing for income effects and extensive margin responses. We provide a sufficient condition for optimal marginal tax rates to be nonnegative everywhere. The relevance of this condition is discussed with analytical examples and numerical simulations on U.S. data.

Keywords: Optimal Tax formula; Tax perturbation; Random participation.; (follow links to similar papers)

JEL-Codes: H21; H23; (follow links to similar papers)

32 pages, January 28, 2010

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