Pareto Efficient Income Taxation with Stochastic Abilities

51 Pages Posted: 27 Nov 2003 Last revised: 25 Feb 2022

See all articles by Marco Battaglini

Marco Battaglini

Princeton University - Department of Economics; Centre for Economic Policy Research (CEPR)

Stephen Coate

Cornell University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: November 2003

Abstract

This paper studies Pareto efficient income taxation in an economy with infinitely-lived individuals whose income generating abilities evolve according to a two-state Markov process. The study yields two main results. First, when individuals are risk neutral, the fraction of individuals who face a positive marginal income tax rate is always positive but converges to zero. Moreover, the tax rate these individuals face also goes to zero. Second, Pareto efficient income tax systems can be time-consistent even when the degree of correlation in ability types is large.

Suggested Citation

Battaglini, Marco and Coate, Stephen, Pareto Efficient Income Taxation with Stochastic Abilities (November 2003). NBER Working Paper No. w10119, Available at SSRN: https://ssrn.com/abstract=471469

Marco Battaglini

Princeton University - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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Stephen Coate (Contact Author)

Cornell University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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