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Title: Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium

Author(s): Dominik Sachs, Aleh Tsyvinski and Nicolas Werquin

Publication Date: September 2016

Keyword(s): General Equilibrium, optimal taxation, Tax Incidence and Tax Reforms

Programme Area(s): Public Economics

Abstract: We study the incidence and the optimal design of nonlinear income taxes in a Mirrleesian economy with a continuum of endogenous wages. We characterize analytically the incidence of any tax reform by showing that one can mathematically formalize this problem as an integral equation. For a CES production function, we show theoretically and numerically that the general equilibrium forces raise the revenue gains from increasing the progressivity of the U.S. tax schedule. This result is reinforced in the case of a Translog technology where closer skill types are stronger substitutes. We then characterize the optimum tax schedule, and derive a simple closed-form expression for the top tax rate. The U-shape of optimal marginal tax rates is more pronounced than in partial equilibrium. The joint analysis of tax incidence and optimal taxation reveals that the economic insights obtained for the optimum may be reversed when considering reforms of a suboptimal tax code.

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Bibliographic Reference

Sachs, D, Tsyvinski, A and Werquin, N. 2016. 'Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11497