New Optimal Income Tax Theory and Japan's Income Tax System

Abstract

This study provides new estimates of the income distribution of high income earners and uses recent empirical findings related to the elasticity of taxable income in Japan to derive the optimal highest marginal tax rate. Based on the 2003 Top Taxpayer Rankings, the Pareto distribution coefficient (α) is estimated to be 2.1. Compared with Mizoguchi (1987), this suggests the possibility that income in Japan is concentrated, though not to the same degree as in the United States, among the top several thousand to several tens of thousands of high income earners. On the other hand, recent empirical research has estimated the elasticity of taxable income to be in the range from 0.051 to 0.28. This result indicates that the optimal highest marginal tax rate in Japan is higher than the current level as long as the social welfare weight attached to the most highly skilled individuals is not too large. It also supports the argument for increasing taxes on high income earners. Also, the elasticity of taxable income is influenced by the withholding tax and year-end adjustment system and by the earned income deduction.