What Should the Optimal Income Tax Rate Be? ()
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.
Share and Cite:
Ben David, N. and Tal Sharon, G. (2019) What Should the Optimal Income Tax Rate Be?.
Modern Economy,
10, 1946-1962. doi:
10.4236/me.2019.108124.
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