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30-08-2017 | Issue 3/2018

International Tax and Public Finance 3/2018

On the optimal lifetime redistribution and social objectives: a multidimensional approach

Journal:
International Tax and Public Finance > Issue 3/2018
Authors:
Terhi Ravaska, Sanna Tenhunen, Matti Tuomala
Important notes
Funding from the Strategic Research Council of Academy of Finland, No. 293120 (STN-WIP-consortium) is gratefully acknowledged. Ravaska also gratefully acknowledges the funding from OP Groups Scientific Foundations.

Abstract

We characterize optimal redistribution policy when there are differences not only in individuals’ productivities but also in their tastes towards the timing of consumption, i.e. some are patient and others impatient in consumption over the life cycle and this preference together with productivity is non-observable to government. We consider different social objectives and incorporate a novel approach taken in the spirit of Roemer (Equality of opportunity, Harvard University Press, Harvard, 1998) and Van de Gaer (Equality of opportunity and investments in human capital, Katholieke Universiteit Leuven, 1993). This approach applies a compromise between the principle of compensation and the principle of responsibility. We derive analytical expressions which describe the optimal distortion (upward or downward) in saving. As the multidimensional problems become very complicated, to gain a better understanding, we also numerically examine the properties of an optimal lifetime redistribution policy. We find support for a nonlinear tax/pension program in which impatient types are taxed at the margin, and patient low ability types are subsidized in their retirement consumption. Numerical simulations show quite big differences in terms of the levels of marginal tax rates between different social objectives, indicating that the optimal income taxation results are sensitive to the choice of the social planner’s goals.

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