Abstract:

This paper calculates optimal linear income taxes when differences in income are caused by random factors (‘luck’) rather than by unobserved individual skills, as assumed in the classical theory of income taxation. As first shown by Varian (1980) [Varian, H.R., 1980. Redistributive taxation as social insurance, Journal of Public Economics 14, 49–68] in the former case income taxation acts as social insurance. By introducing life uncertainty and precautionary behavior, we find higher optimal marginal tax rates than those found by Varian. We also find that – in the context of a piecewise two-bracket linear tax schedule – the second marginal tax is higher than the first, a finding that contrasts with results recently obtained in the framework of classical income taxation theory, which show a lower second marginal tax.