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Optimal Redistributive Taxation$
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Matti Tuomala

Print publication date: 2016

Print ISBN-13: 9780198753414

Published to Oxford Scholarship Online: March 2016

DOI: 10.1093/acprof:oso/9780198753414.001.0001

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Income uncertainty and optimal redistribution

Income uncertainty and optimal redistribution

Chapter:
(p.259) 11 Income uncertainty and optimal redistribution
Source:
Optimal Redistributive Taxation
Author(s):

Matti Tuomala

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780198753414.003.0011

Chapter 11 first reviews the standard, benchmark, model of optimal taxation with moral hazard under income uncertainty and then characterizes optimal tax rules when individual behaviour is described by prospect theory. In the Mirrlees (1971) model of optimal income taxation, there is no uncertainty. Once skill type is revealed, individual controls income perfectly. In practice, there is considerable uncertainty in incomes. Income is partly due to individual effort and partly due to luck, but the government can only observe realized income, not effort. In this case, a redistributive tax system can be interpreted as a form of social insurance against the possible bad fortune of being endowed with low abilities. The optimal redistribution scheme is a balance between providing the workers with adequate incentives to acquire skills and sufficient insurance.

Keywords:   moral hazard, prospect theory, uncertainty, non-welfarism, insurance, non-linear taxation

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