Tax Preferences and Optimal Income Taxation

Marcelo Arbex and Enlinson Mattos

No 2006, Working Papers from University of Windsor, Department of Economics

Abstract: We develop a two-agent model where agents have preferences over consumption, leisure, independent and interdependent tax preferences - personal (own tax payments) and interpersonal (average tax payments in the economy). We characterize the optimal labor income taxation under different assumptions regarding tax preferences (tax affinity, hostility, conformity and opposition). We find that tax preferences can either amplify or reduce the marginal tax increase of the low-ability type. When individuals can hide a fraction of their earnings at a resource cost, the link between consumption and tax payments is broken. Tax evasion affects the aggregate measure of taxes and what people take into account and care about when making their optimal decisions. We find that the trade-off associated with tax preferences and consumption have their effects intensified in the optimal low-ability income tax. With evasion, the marginal income tax of high-ability types is no longer zero - it is optimal to subsidize this type and avoid the mimicking of low-ability individuals.

Keywords: Optimal taxation; Social preferences; Tax affinity; Pro-social behavior. (search for similar items in EconPapers)
JEL-codes: D03 D60 H21 H23 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2020-10
New Economics Papers: this item is included in nep-iue, nep-pbe and nep-pub
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http://web2.uwindsor.ca/economics/RePEc/wis/pdf/2006.pdf First version, 2020 (application/pdf)

Related works:
Working Paper: Tax preferences and optimal income taxation (2020)
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