2016-12 , Center for Research on Contemporary Economic Systems, Graduate School of Economics, Hitotsubashi University
This version: December 1, 2016 This study examines optimal nonlinear income taxes when individuals differ in their preference for a public good and labor productivity. We consider two regions, of which one provides a higher quality public service than the other, thus inducing individuals to "vote with their feet." In addition, the government implements a region-specific income tax schedule to reflect the difference in benefits from the public service between the regions in the tax system. We show that if two characteristics are independently distributed and the first derivative of the social welfare function is strictly convex, the marginal tax rate in the region providing the higher quality public service is lower since the participation effect is greater than the mechanical effect. Further, we numerically find that the correlation can be substantial in differentiating income tax schedules, although labor mobility weakens the differentiation of marginal tax rates on the basis of a positive correlation between the two characteristics.