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Optimal Nonlinear Taxation of Income and Savings in a Two Class Economy

Author

Listed:
  • Craig Brett

    (Department of Economics, Mount Allison University)

  • John A. Weymark

    (Department of Economics, Vanderbilt University)

Abstract

Optimal nonlinear taxation of income and savings is considered in a two-period model with two individuals who have additively separable preferences and who only differ in their skill levels. When the government can commit to its second period policy, taxes on savings do not form part of the optimal tax mix. When commitment is not possible, the optimal tax scheme distorts private savings behavior. If the types are separated in period one, it is optimal to subsidize the savings of both types of individual at the margin. If the types are pooled in period one, it is optimal for the low-skilled (high-skilled) individual to face a marginal savings tax (subsidy). In both cases, the subsidy to the high-skilled individual helps offset his disincentive to save that arises because some of his savings will be redistributed to the low-skilled individual in the second period. The savings of the low-skilled individual in the separating case are taxed so as to relax an incentive compatibility constraint.

Suggested Citation

  • Craig Brett & John A. Weymark, 2005. "Optimal Nonlinear Taxation of Income and Savings in a Two Class Economy," Vanderbilt University Department of Economics Working Papers 0525, Vanderbilt University Department of Economics.
    • Handle: RePEc:van:wpaper:0525
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    References listed on IDEAS

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    Cited by:

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    3. Lasse Frisgaard Gunnersen & Bo Sandemann Rasmussen, 2012. "Optimal Tax-Transfer Policies, Life-Cycle Labour Supply and Present-Biased Preferences," Economics Working Papers 2012-12, Department of Economics and Business Economics, Aarhus University.
    4. Thomas Gaube, 2007. "Optimum Taxation of Each Year's Income," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(1), pages 127-150, February.

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    More about this item

    Keywords

    Asymmetric information; commitment; dynamic optimal taxation; optimal income taxation; savings taxation; time consistency;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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