Practical Optimal Income Taxation

Jonathan Heathcote and Hitoshi Tsujiyama

No 19857, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We review approaches to formulating and solving optimal tax problems in heterogeneous-agent economies. We first show that whether worker heterogeneity is represented through a small or a large number of different productivity types controls the tightness of incentive constraints facing the Mirrlessian planner and therefore has an important impact on policy prescriptions. A popular computational approach that iterates on the Diamond-Saez implicit optimal tax formula does not deliver the constrained efficient allocation when a coarse productivity grid is used. For the purpose of providing quantitative policy recommendations, one safe approach is to solve for the Mirrleesian optimum assuming a very fine grid of productivity types. Alternatively, one can formulate the problem assuming that the distribution of types is continuous, and search for a numerical solution to the system of ordinary differential equations that then define the optimal policy. If these options are infeasible, then optimizing within a flexible parametric class for taxes is preferable to a coarse grid Mirrleesian approach.

Keywords: Optimal taxation; Mirrleesian taxation (search for similar items in EconPapers)
JEL-codes: H21 H31 (search for similar items in EconPapers)
Date: 2025-01
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP19857 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:19857

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP19857

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().