Optimal Redistributive Policies by Publicly Provided Inputs and Income Taxation

Abstract

Governments redistribute by means of taxes, transfers, and public services. Relying on three sufficient statistics, we characterize the conditions under which nonlinear income taxation is optimally combined with input public provision in two-class and multi-class economies, where individual wages are driven by households’ exogenous capabilities and input investments. A universal scheme, such that all households opt for a large and uniform level of publicly provided input, optimally compound with nonlinear income taxation, if higher-capability households demand less (publicly provided) input than the lower-capability do. Otherwise, pure nonlinear taxation is optimal. Calibrating our model with U.S. data, we find that the former case is empirically relevant.