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The Optimal Asymptotic Income Tax Rate

Author

Listed:
  • Momi Dahan

    (Hebrew University of Jerusalem)

  • Michel Strawczynski

    (Bank of Israel)

Abstract

Recent works on optimal income tax found that for unbounded distributions of earnings the optimal tax rate at the top is relatively high (around 60 percent). This finding is puzzling in light of the well-known result for bounded distributions of a zero optimal tax rate at the top. Our paper shows that the more recent papers have used assumptions that favor a high asymptotic tax rate: Pareto instead of Log-normal distribution and linear instead of non-linear utility of consumption. Using these two assumptions along with a logarithmic utility of leisure leads to an optimal rate of 100%, a result that is avoided in recent literature by assuming a constant compensated elasticity of labor. We find that even when using a Pareto distribution of earnings the optimal asymptotic tax rate is about a half compared to recent literature.

Suggested Citation

  • Momi Dahan & Michel Strawczynski, 2004. "The Optimal Asymptotic Income Tax Rate," Bank of Israel Working Papers 2004.15, Bank of Israel.
    • Handle: RePEc:boi:wpaper:2004.15
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    References listed on IDEAS

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    1. Daniel R. Feenberg & James M. Poterba, 1993. "Income Inequality and the Incomes of Very High-Income Taxpayers: Evidence from Tax Returns," NBER Chapters, in: Tax Policy and the Economy, Volume 7, pages 145-177, National Bureau of Economic Research, Inc.
    2. Stiglitz, Joseph E., 1987. "Pareto efficient and optimal taxation and the new new welfare economics," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 2, chapter 15, pages 991-1042, Elsevier.
    3. Tuomala, Matti, 1984. "On the optimal income taxation : Some further numerical results," Journal of Public Economics, Elsevier, vol. 23(3), pages 351-366, April.
    4. Emmanuel Saez, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 68(1), pages 205-229.
    5. repec:bla:scandj:v:96:y:1994:i:2:p:275-82 is not listed on IDEAS
    6. Michel Strawczynski & Momi Dahan, 2000. "Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates: Comment," American Economic Review, American Economic Association, vol. 90(3), pages 681-686, June.
    7. Diamond, Peter A, 1998. "Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates," American Economic Review, American Economic Association, vol. 88(1), pages 83-95, March.
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    Cited by:

    1. Boadway, Robin & Jacquet, Laurence, 2008. "Optimal marginal and average income taxation under maximin," Journal of Economic Theory, Elsevier, vol. 143(1), pages 425-441, November.
    2. Louis Kaplow, 2022. "Optimal Income Taxation," NBER Working Papers 30199, National Bureau of Economic Research, Inc.
    3. Michel Strawczynski, 2020. "Optimal EITC in the Presence of Cultural Barriers for Labor Market Participation," Journal of Labor Research, Springer, vol. 41(3), pages 233-259, September.
    4. Kanbur, Ravi & Tuomala, Matti, 2024. "How Does Predistribution Affect Redistribution?," CEPR Discussion Papers 18758, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Optimal Income Tax;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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