The Optimal Two-Bracket Linear Income Tax

33 Pages Posted: 7 Aug 2007 Last revised: 15 Jul 2010

See all articles by Joel B. Slemrod

Joel B. Slemrod

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research (NBER)

Shlomo Yitzhaki

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

Joram Mayshar

Hebrew University of Jerusalem - Department of Economics

Date Written: September 1991

Abstract

We investigate the optimal rate structure of an income tax system that is constrained to have only two brackets, plus a demogrant. We find that, in a two-class economy, Pareto efficient tax schedules feature at least one marginal tax rate equal to zero, and that the marginal tax rate may be increasing or declining. We next use numerical optimization techniques to study the optimal structure of such a tax system in a multi-person model that is a stylized version of an actual economy. We discover that in all cases the tax rate in the second (higher) bracket is less than the tax rate that applies to the first bracket but that progressivity, in the sense of a uniformly rising average tax rate, generally obtains. Compared to the optimal one-bracket (linear) tax system, both the highest and lowest income individuals are better off, while a middle range of taxpayers is worse off.

Suggested Citation

Slemrod, Joel B. and Yitzhaki, Shlomo and Mayshar, Joram, The Optimal Two-Bracket Linear Income Tax (September 1991). NBER Working Paper No. w3847. Available at SSRN: https://ssrn.com/abstract=473979

Joel B. Slemrod (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

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Shlomo Yitzhaki

Hebrew University of Jerusalem - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Joram Mayshar

Hebrew University of Jerusalem - Department of Economics ( email )

Mount Scopus
Jerusalem, 91905
Israel
+972 02-5883138 (Phone)
+972 02-5816071 (Fax)

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