The Simple Economics of Bunching: Optimal Taxation with Quasi-Linear Preferences

Jan Boone and Ary Lans Bovenberg ()

Journal of Public Economic Theory, 2007, vol. 9, issue 1, pages 89-105

Abstract: This paper models unemployment as a binding nonnegativity constraint on hours worked in an optimal income tax problem with quasi-linear preferences. We show that bunching of workers resulting from this binding constraint provides a more convincing description of the bottom of the labor market than bunching due to violation of the second-order condition for individual optimization. Although a binding nonnegativity constraint destroys the closed form solution of optimal marginal tax rates, the optimal tax problem can be characterized in a two-dimensional diagram in which comparative statics can be performed in straightforward fashion. Copyright 2007 Blackwell Publishing, Inc..

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