Optimal Income Taxation and Risk: The Extensive-Margin Case

Abstract

The optimal income tax structure is studied in a setting in which workers make discrete labor market decisions and earnings are uncertain. Workers differ continuously along a single dimension that reflects their skills as well as their disutility of work in different jobs. A discrete number of skill-types of jobs are available in perfectly elastic supply. Each job yields a stochastic distribution of wages, where the distribution differs among skill-types. The amount of work in each job is fixed, so there is no intensive labor-supply decision and wages reflect earnings. Expected wages for a given skill-type of job are higher for higher-skilled workers. Workers first choose a job based on the distribution of wages they expect to earn in different jobs. Once jobs are chosen, wages are revealed and workers decide whether to participate in the job or to become voluntarily unemployed. Each job will be associated with a distribution of wages, and the same wage will be paid by more than one type of job. Under reasonable conditions, workers segment themselves by skill levels into jobs. We analyze the optimal income tax structure given these two margins of decision-making, job choice and participation. The optimal tax will reflect insurance (since earnings are uncertain when jobs are chosen), redistribution (since persons of higher skills earn more), and efficiency (since taxes affect both job choice and participation). The form of the tax structure is comparable to that obtained when labor supply can be varied along the intensive margin.

Taxing the Job Creators: Efficient Progressive Taxation with Wage Bargaining

“…Rothschild and Scheuer (2013) andBoadway and Sato (2014) also study taxation with different types of jobs, but in a different setting in which jobs are not hierarchical, but rather correspond to an extensive-margin decision between different occupations.8 The result of a declining optimal rate near the top of the income distribution is due to the assumption of a finite top to the distribution; in the usual Mirrleesian analysis with competitive labour markets, the optimal top tax rate is zero.…”