Optimal taxation with multiple dimensions of heterogeneity

Katy Bergstrom and William Dodds

Journal of Public Economics, 2021, vol. 200, issue C

Abstract: This paper develops a general theory of optimal income taxation with multiple dimensions of agent heterogeneity. The main technical hurdle in developing this theory is the possibility that individuals have multiple optimal incomes. Using a perturbation approach, we derive optimal tax formulas that account for the possibility that individuals have multiple optima and, hence, account for the possibility that individuals jump between their optimal income levels when we perturb the tax schedule. We quantify the magnitude of these effects, thereby augmenting the optimal tax formulas from Saez (2001) with additional “jumping effect” terms. We provide a partial characterization of when individuals with multiple optimal incomes may exist under the optimal tax schedule. Finally, we derive a new methodology to simulate optimal income tax schedules with multidimensional heterogeneity. We implement this method numerically, showing that individuals with multiple optimal income levels can exist under the optimal tax schedule.

Keywords: Optimal taxation; Tax perturbation; Multiple dimensions; Jumping effects (search for similar items in EconPapers)
JEL-codes: H2 H21 H24 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:pubeco:v:200:y:2021:i:c:s0047272721000785

DOI: 10.1016/j.jpubeco.2021.104442

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