On Optimal Income Taxation with Heterogenous Work Preferences

Abstract

This paper considers the problem of optimal income taxation when individuals are assumed to differ with respect to their earnings potential and work preferences. A numerical method for solving this two-dimensional problem has been developed. We assume an additive utility function, and utilitarian social objectives. Rather than solve the first order conditions associated with the problem, we directly compute the best tax function which can be written in terms of a second order B-spline function. Among our findings are that marginal tax rates are higher than one might anticipate, and that very little bunching occurs at the optimum.