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Free keywords:
Optimal income taxation, Extensive margin, Intensive margin
JEL:
H21 - Efficiency; Optimal Taxation
JEL:
H23 - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
JEL:
D82 - Asymmetric and Private Information; Mechanism Design
Abstract:
This paper studies optimal non-linear income taxation in an empirically plausible model with labor supply responses at the intensive (hours, effort) and the extensive (participation) margin. In this model, redistributive taxation gives rise to a previously neglected trade-off between two aspects of effciency: To reduce the deadweight loss from distortions at the extensive margin, the social planner has to increase distortions at the intensive margin and vice versa. Due to this trade-off, minimizing the overall deadweight loss requires to distort labor supply by low-skill workers upwards at both margins. Building on these insights, the paper is the first to provide conditions under which social welfare is maximized by an Earned Income Tax Credit with negative marginal taxes and negative participation taxes at low income levels.
