The Wage Rate Tax—An Alternative to the Income Tax?

During the last decade, as income tax rates have continuously climbed to new heights, the deficiencies of the income tax system have become more and more conspicuous. This has induced a search for alternative tax bases. Some aspects of whether a wage-rate tax might be a good alternative to the income tax are examined in this paper. Through simulations with a one-period optimal taxation model, where individuals are free to choose both the amount of education, which influences their wage rates, and hours of work, the optimal linear wage-rate tax is compared to the optimal linear income tax. Special interest is paid to how the relative performance of the two tax systems depends on the elasticity of the wage rate with respect to education, and the elasticity of substitution in individuals’ utility functions.