Using Consumption Data to Derive Optimal Income and Capital Tax Rates

Résumé

We study a Mirrleesian economy with labor income, consumption, and retirement savings or bequests. We derive a novel representation of optimal non-linear income and savings distortions that highlights the role of consumption inequality and consumption responses to tax changes. Our representation establishes a close connection between the formula for top income taxes of Saez (2001) and the uniform commodity taxation theorem of Atkinson and Stiglitz (1976): One cannot be valid without the other, and departures from this joint benchmark lead to a clear trade-off between income and savings taxes. Consumption data in turn discipline the optimal departure from this benchmark. Because consumption is much less concentrated than income, it is optimal to shift a substantial fraction of the top earners’ tax burden from income to savings.