Optimal Taxation of Indistinguishable Activities

Jacob Goldin, Sebastian Koehne and Nicholas Lawson

No 13077, CESifo Working Paper Series from CESifo

Abstract: Optimal tax policy frequently prescribes different tax treatments for activities that are difficult in practice for tax administrators to distinguish, such as expenditures undertaken for business versus personal purposes. We study the optimal design of income tax deductions for such expenditures under the assumption that a common deduction rate must be applied to both forms of the expenditure. The Pareto optimal common deduction turns on the relative compensated spending response for each margin, weighted by the income tax wedge. We also characterize the welfare gain from distinguishing between the two expenditure forms as a harmonic mean of the compensated responses. We illustrate both results with an application to air travel expenses.

Keywords: optimal taxation; tax deductions; indistinguishable expenditures; tax administration; business and personal expenses (search for similar items in EconPapers)
JEL-codes: D82 H21 H24 (search for similar items in EconPapers)
Date: 2026
New Economics Papers: this item is included in nep-inv
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