Working Paper: NBER ID: w10119
Authors: 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.
Keywords: income taxation; Pareto efficiency; stochastic abilities; dynamic taxation
JEL Codes: H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Individuals' ability types (D29) | Tax rates (H29) |
| Risk neutrality (D81) | Fraction facing positive marginal income tax rate (H31) |
| Fraction facing positive marginal income tax rate (H31) | Tax rate (H29) |
| High correlation in ability types (C10) | Time consistent Pareto efficient tax systems (H21) |
| Risk aversion (D81) | Positive marginal tax rate for low ability individuals (H31) |
| Slight risk aversion (D81) | Distortion imposed on low ability individuals (H31) |
| Risk preferences (D81) | Labor supply distortions (J29) |