DP13852 Pareto-Efficient Tax Deductions

Author(s): Sebastian Koehne, Dominik Sachs
Publication Date: July 2019
Keyword(s): optimal taxation, Pareto-Improving Tax Reform, Tax Deduction
JEL(s): D82, H21
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13852

We analyze Pareto-e�cient tax deduction rules for work-related expenses (e.g. housekeeping services, child care or elderly care). Pareto e�ciency dictates a tight rule for how the rate of deductibility should vary with income and expenditures. An immediate implication is a recipe for designing Pareto-improving tax reforms. We apply our theory to housekeeping services in the U.S.: Introducing deduction rules such that between 55% (low expenses) and 85% (high expenses) of housekeeping services can be marginally deducted from taxable income yields a Pareto improvement if combined with a slight increase in marginal tax rates. Nobody is made worse-o� and tax revenue increases by 20 Dollars per capita.