DP16797 Optimal Taxation with Multiple Incomes and Types
We analyze the optimal nonlinear income tax schedule when taxpayers earn multiple incomes and differ along many unobserved dimensions. We compare the tax perturbation and mechanism design approaches and find that both produce the same results if the number of incomes is equal to the number of unobserved characteristics. The mechanism design approach then requires slightly less stringent assumptions than the tax perturbation approach. We introduce a numerical method to determine the optimal tax schedule. Applied to the optimal taxation of couples, we find that the optimal isotax curves are close to linear and parallel. We make several additional contributions, including a test for Pareto efficiency and a condition on primitives that ensures the government’s necessary conditions are sufficient and the solution to the problem is unique.
