Nicolas Werquin (Federal Reserve Bank of Chicago), 19.04.2023

Title: “A Fair Day’s Pay for a Fair Day’s Work: Optimal Tax Design as Redistributional Arbitrage”

We study optimal tax design based on the idea that policy-makers face trade-offs between
multiple margins of redistribution. Within a Mirrleesian economy with labor income, consumption,
and retirement savings, we derive a novel formula for optimal non-linear income and savings
distortions based on redistributional arbitrage. We establish a sufficient statistics representation
of the labor income and capital tax rates on top earners, which relies on comparing the
Pareto tails of income and consumption. Because consumption is more evenly distributed than
income, it is optimal to shift a substantial fraction of the top earners’ tax burden from income
to savings. We extend our representation of tax distortions based on redistributional arbitrage
to economies with general preferences over an arbitrary number of periods and commodities,
and we allow for return heterogeneity, age-contingent taxes, and stochastic evolution of types.
Coauthor: Christian Hellwig