DP4190 Optimal Dynamic Taxation with Indivisible Labour

Author(s): Parantap Basu, Laura Marsiliani, Thomas I Renström
Publication Date: January 2004
Keyword(s): dynamic taxation, indivisible labour, optimal taxation
JEL(s): E62, H21
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4190

In this Paper, we take the field of optimal dynamic taxation further in two directions. Using a model with invisible labour, as in Hansen (1986) and Rogerson (1988), we first explore the short-run dynamics of the capital-income tax, particularly whether the tax, under the second-best programme, goes to zero in finite or infinite time. We derive two classes of preferences for which the optimal capital tax reaches zero in a finite time. Second, we ask what preference structures will leave labour untaxed at all times? An exponential preference structure is derived, for which labour is untaxed both in the short and long run.