Differential Income Taxation and Tiebout Sorting

Abstract

This study examines optimal nonlinear income taxes when individuals differ in their preference for a public good and labor productivity. We consider two regions, of which one provides a higher-quality public service than the other, thus inducing individuals to vote with their feet. The government implements a region-specific income tax schedule to reflect the difference in benefits from the public service between the regions in the tax system. We demonstrate that the optimal structure of the tax system is dramatically reformed, depending on whether individuals can move or not.