Abstract
In this paper, we present a model that enables us to calculate the optimal income tax rate, given a specific utility function from leisure and consumption of private and public goods. The main contribution of our paper is presenting a new approach for determining the optimal tax rate: instead of focusing on the social planner’s point of view, we focus on the private agent’s point of view. We assume a given labor supply function and calculate the loss of income which equals increased government supply following tax imposition. Taking into consideration the loss of utility following decreased private consumption as well as increased public utility following increased leisure and public consumption, we calculate the income tax rate that would maximize an agent’s benefit. We examined our model by gradually changing labor supply elasticity, wage per hour, and the parameter of marginal utility from public consumption. We find that as labor supply elasticity increases, the optimal tax rate should be lower. On the other hand, as wage per hour increases, the optimal tax rate should be higher. Finally, as the parameter increasing utility from public consumption is lower, the optimal tax is lower.
Highlights
Imposing income tax reduces the net wage per-hour by changing the value of leisure and the supply of labor
We examined our model by gradually changing labor supply elasticity, wage per hour, and the parameter of marginal utility from public consumption
We find that as labor supply elasticity increases, the optimal tax rate should be lower
Summary
Imposing income tax reduces the net wage per-hour by changing the value of leisure and the supply of labor. In the [2] model, workers are endowed with heterogenous productivities or skills known only to themselves and to their employers, labor supply varies with work effort and the optimal marginal tax rate is determined for any given income or skill. [5] characterized the optimal tax schedule in a model where the only decision made by individuals is regarding their participation decision He derived the tax system that maximized government revenue as a function of the distribution of productivities and work opportunity cost. Defining a target function that adds the aggregated reduction in marginal benefit from private consumption following the tax imposition, while adding to it the aggregated marginal benefits from the supply of new public goods and the aggregate increase in leisure, we could maximize the function subject to income tax and find the optimal tax rate
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