Scandinavian Working Papers in Economics

Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

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

Laurence Jacquet (), Etienne Lehmann () and Bruno Van der Linden ()
Additional contact information
Laurence Jacquet: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Economics, Helleveien 30, N-5045 Bergen, Norway
Etienne Lehmann: CREST-INSEE, Postal: Timbre J360, 15 boulevard Gabriel Péri, 92245, Malakoff Cedex, , France.
Bruno Van der Linden: IRES, Postal: Département d’économie, , Université Catholique de Louvain, , Place Montesquieu 3, B1348,, Louvain-la-Neuve, Belgium.

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.

JEL-codes: H21; H23

32 pages, January 28, 2010

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