Signing Distortions in Optimal Tax and Other Adverse Selection Problems with Random Participation
33 Pages Posted: 4 Apr 2012
Date Written: March 30, 2012
We develop a methodology to sign output distortions in the random participation framework. We apply our method to monopoly nonlinear pricing problem, to the regulatory monopoly problem and mainly to the optimal income tax problem. In the latter framework, individuals are heterogeneous across two unobserved dimensions: their skill and their disutility of participation to the labor market. We derive a fairly mild condition for optimal marginal tax rates to be non negative everywhere, implying that in-work effort is distorted downwards. Numerical simulations for the U.S. confirm this property. Moreover, it is typically optimal to provide a distinct level of transfer to the non-employed and to workers with zero or negligible earnings.
Keywords: adverse selection, optimal taxation, random participation
JEL Classification: H210, H230
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