Mirrlees Meets Diamond-Mirrlees

35 Pages Posted: 14 Mar 2016

See all articles by Florian Scheuer

Florian Scheuer

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Iván Werning

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: March 2016

Abstract

We show that the Diamond and Mirrlees (1971) linear tax model contains the Mirrlees (1971) nonlinear tax model as a special case. In this sense, the Mirrlees model is an application of Diamond-Mirrlees. We also derive the optimal tax formula in Mirrlees from the Diamond-Mirrlees formula. In the Mirrlees model, the relevant compensated cross-price elasticities are zero, providing a situation where an inverse elasticity rule holds. We provide four extensions that illustrate the power and ease of our approach, based on Diamond-Mirrlees, to study nonlinear taxation. First, we consider annual taxation in a lifecycle context. Second, we include human capital investments. Third, we incorporate more general forms of heterogeneity into the basic Mirrlees model. Fourth, we consider an extensive margin labor force participation decision, alongside the intensive margin choice. In all these cases, the relevant optimality condition is easily obtained as an application of the general Diamond-Mirrlees tax formula.

Suggested Citation

Scheuer, Florian and Werning, Ivan, Mirrlees Meets Diamond-Mirrlees (March 2016). NBER Working Paper No. w22076, Available at SSRN: https://ssrn.com/abstract=2747196

Florian Scheuer (Contact Author)

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Ivan Werning

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