Optimal fiscal and public expenditure policy in a two-class economy

Abstract

The paper deals with optimal taxation and the provision of public goods in a two-class economy with non-linear income and linear commodity taxes. As far as optimal taxation is concerned, we first show that with two private goods the good complementary with leisure should be taxed more heavily. Secondly, the standard income tax rules are shown to be augmented by considerations for offsetting the distortions created on the commodity markets. As to the provision of public goods we extend recent results for a two-class economy with public funds raised entirely by means of a non-linear income tax system. The standard Samuelson rule is modified by two additional terms related to the self-selection constraint and to the revenue of indirect taxes. They are both shown to vanish when the agents' utility functions are weakly separable between public and private goods (taken together) and leisure.