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The Simple Economics of Bunching: Optimal Taxation with Quasi‐Linear Preferences
Author(s) -
BOONE JAN,
BOVENBERG LANS
Publication year - 2007
Publication title -
journal of public economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.809
H-Index - 32
eISSN - 1467-9779
pISSN - 1097-3923
DOI - 10.1111/j.1467-9779.2007.00299.x
Subject(s) - comparative statics , constraint (computer aided design) , economics , unemployment , simple (philosophy) , mathematical economics , order (exchange) , mathematical optimization , microeconomics , mathematics , macroeconomics , philosophy , geometry , epistemology , finance
This paper models unemployment as a binding nonnegativity constraint on hours worked in an optimal income tax problem with quasi‐linear preferences. We show that bunching of workers resulting from this binding constraint provides a more convincing description of the bottom of the labor market than bunching due to violation of the second‐order condition for individual optimization. Although a binding nonnegativity constraint destroys the closed form solution of optimal marginal tax rates, the optimal tax problem can be characterized in a two‐dimensional diagram in which comparative statics can be performed in straightforward fashion.