On Optimal Income Taxation with Heterogenous Work Preferences

Ritva Tarkiainen and Matti Tuomola

No 97-16, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: This paper considers the problem of optimal income taxation when individuals are assumed to differ with respect to their earnings potential and work preferences. A numerical method for solving this two-dimensional problem has been developed. The problem is difficult to solve, but we managed to solve some examples. The numerical results obtained give us a direction to influences that richer picture of population would have on the income tax schedule. On the basis of our numerical results we conclude that the tax system is more redistributive compared to those obtained from the one-dimensional case. This may be surprising to those who believe that taking into account different work preferences is an argument for having less redistribution and hence lower levels of income taxation and social security payments.

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