Optimal Income Tax in an Extensive Labor Supply Life-cycle Model
Abstract
This article considers a stationary economy populated with overlapping generations that reproduce identically in continuous time. Each dynasty has a productivity and an opportunity cost of going to work that vary with age. Labor supply is extensive. At each date, the typical agent can either work full time or not work at all. The decision to work is based on a comparison between after tax income and the privately known opportunity cost of work. We assume that the utilitarian government, which aims at redistributing lifetime utility across dynasties, has a single policy instrument, a stationary income tax schedule function of current income. The article develops a method to study the government problem. This technique is applied to derive the properties of the optimal income tax schedule in a number of examples.
