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A theory of income taxation under multidimensional skill heterogeneity - Zurich Open Repository and Archive


Rothschild, Casey; Scheuer, Florian (2014). A theory of income taxation under multidimensional skill heterogeneity. NBER Working papers 19822, University of Zurich.

Abstract

We develop a unifying framework for optimal income taxation in multi-sector economies with general patterns of externalities. Agents in this model are characterized by an N-dimensional skill vector corresponding to intrinsic abilities in N potentially externality-causing activities. The private return to each activity depends on individual skill and an aggregate activity-specific return, which is a fully general function of the economy-wide distribution of activity-specific efforts. We show that the N-dimensional heterogeneity can be collapsed to a one-dimensional, endogenous statistic sufficient for screening. The optimal tax schedule features a multiplicative income-specific correction to an otherwise standard tax formula. Because externalities change the relative returns to different activities, corrective taxes induce changes in the across-activity allocation of effort. These relative return effects cause the optimal correction to diverge, in general, from the Pigouvian tax that would align private and social returns. We characterize this divergence and its implications for the shape of the tax schedule both generally and in a number of applications, including externality-free economies, increasing and decreasing returns to scale, zero-sum activities such as bargaining or rent extraction, and positive or negative spillovers.

Abstract

We develop a unifying framework for optimal income taxation in multi-sector economies with general patterns of externalities. Agents in this model are characterized by an N-dimensional skill vector corresponding to intrinsic abilities in N potentially externality-causing activities. The private return to each activity depends on individual skill and an aggregate activity-specific return, which is a fully general function of the economy-wide distribution of activity-specific efforts. We show that the N-dimensional heterogeneity can be collapsed to a one-dimensional, endogenous statistic sufficient for screening. The optimal tax schedule features a multiplicative income-specific correction to an otherwise standard tax formula. Because externalities change the relative returns to different activities, corrective taxes induce changes in the across-activity allocation of effort. These relative return effects cause the optimal correction to diverge, in general, from the Pigouvian tax that would align private and social returns. We characterize this divergence and its implications for the shape of the tax schedule both generally and in a number of applications, including externality-free economies, increasing and decreasing returns to scale, zero-sum activities such as bargaining or rent extraction, and positive or negative spillovers.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Dewey Decimal Classification:330 Economics
JEL Classification:D5, D6, D8, E2, H2, J3
Language:English
Date:January 2014
Deposited On:11 Aug 2017 12:49
Last Modified:11 Aug 2017 12:49
Series Name:NBER Working papers
Number of Pages:48
Publisher DOI:https://doi.org/10.3386/w19822
Related URLs:http://www.nber.org/papers/w19822

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