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Is the Flat Tax Optimal under Income Risk?

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  • Dominique Henriet

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)

  • Patrick A. Pintus

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)

  • Alain Trannoy

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)

Abstract

We derive testable conditions ensuring that the income tax is optimal when agents are ex-ante identical but face idiosyncratic income risk. The optimal tax depends positively on both absolute risk aversion and risk variance and negatively on labor supply elasticity and absolute prudence. The comparison with the formula of the optimal non-linear income tax provides the restrictions on both the preferences and the income distribution conditional on effort ensuring that the optimal tax is indeed linear. In general it requires that the ratio of absolute prudence to absolute risk aversion be no less than two; if the income density has a linear likelihood ratio, it requires a (generalized) logarithmic consumption utility. Under HARA utility and linear or logarithmic likelihood ratios, explicit solutions for the optimal non-linear income tax are derived.

Suggested Citation

  • Dominique Henriet & Patrick A. Pintus & Alain Trannoy, 2014. "Is the Flat Tax Optimal under Income Risk?," Working Papers halshs-00999222, HAL.
    • Handle: RePEc:hal:wpaper:halshs-00999222
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00999222
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    References listed on IDEAS

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    Cited by:

    1. Robin Boadway & Motohiro Sato, 2015. "Optimal Income Taxation with Risky Earnings: A Synthesis," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 17(6), pages 773-801, December.

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    More about this item

    Keywords

    optimal income taxation; income risk; linear and nonlinear income tax;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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