The Optimal Asymptotic Income Tax Rate

Authors


  • Momi Dahan, Hebrew University of Jerusalem, School of Public Policy, Mount Scopus, Jerusalem 91905, Israel (momidahan@mscc.huji.ac.il). Michel Strawczynski, Hebrew University of Jerusalem, School of Public Policy, Mount Scopus, Jerusalem 91905, Israel (michel.strawczynski@mail.huji.ac.il).

  • We thank Louis Kaplow for his questions and comments that helped instigate this project. We also wish to thank Efraim Sadka, Emmanuel Saez, Avi Simhon, Eytan Sheshinsky, Jonathan Stupp, Shlomo Yitzhaki and the seminar participants at Tel-Aviv University, Hebrew University of Jerusalem, Israel Economic Association, Queens University, and Bank of Portugal for their helpful comments.

Abstract

This paper shows that a policy maker needs only two types of information to set the optimal income tax rate at the top: a measure of labor supply elasticity and the shape of skills distribution. We find that the asymptotic tax rate is not affected by the degree of inequality aversion as long as the marginal utility of consumption converges to zero. By using empirically plausible estimates for the compensated labor supply elasticity and the shape of skills distribution, we find that the optimal marginal tax rate at the top should be between 33% and 60%, which is in line with the existing rates in the real world.

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