Is the Flat Tax Optimal under Income Risk?

Dominique Henriet, Patrick Pintus and Alain Trannoy

No 1420, AMSE Working Papers from Aix-Marseille School of Economics, France

Abstract: We derive testable conditions ensuring that the income tax is optimal when agents are ex-ante identical but face idiosyncratic income risk. The optimal tax depends positively on both absolute risk aversion and risk variance and negatively on labor supply elasticity and absolute prudence. The comparison with the formula of the optimal non-linear income tax provides the restrictions on both the preferences and the income distribution conditional on effort ensuring that the optimal tax is indeed linear. In general it requires that the ratio of absolute prudence to absolute risk aversion be no less than two; if the income density has a linear likelihood ratio, it requires a (generalized) logarithmic consumption utility. Under HARA utility and linear or logarithmic likelihood ratios, explicit solutions for the optimal non-linear income tax are derived.

Keywords: Optimal Income Taxation; Income Risk; Linear and Nonlinear Income Tax. (search for similar items in EconPapers)
JEL-codes: H21 H24 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2014-05-30, Revised 2014-05-30
New Economics Papers: this item is included in nep-pbe, nep-pub and nep-upt
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Citations: View citations in EconPapers (1)

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Working Paper: Is the Flat Tax Optimal under Income Risk? (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:aim:wpaimx:1420

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