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Working Paper, No. 2022-03, January 2022 Crossref
A Fair Day’s Pay for a Fair Day’s Work: Optimal Tax Design as Redistributional Arbitrage

(Revised August 2022)

We study optimal tax design based on the idea that policy-makers face trade-offs between multiple margins of redistribution. Within a Mirrleesian economy with earnings, consumption and retirement savings, we derive a novel formula for optimal non-linear income and savings distortions based on redistributional arbitrage. We establish a sufficient statistics representation of the labor income and capital tax rates on top income earners, which relies on comparing the Pareto tails of income and consumption. Because consumption is more evenly distributed than income, it is optimal to shift a substantial fraction of the top earners’ tax burden from income to savings. We extend our results to economies with one-dimensional heterogeneity and general preferences over an arbitrary number of periods and commodities..

Working papers are not edited, and all opinions and errors are the responsibility of the author(s). The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.


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