Static and Dynamic Mirrleesian Taxation with Non-separable Preferences: A Unified Approach

Abstract

I analyze dynamic Mirrlees taxation with preferences that are non-separable between consumption, leisure and type, which determines both ability and consumption needs. I show how to account for non-separable preferences through a simple change in probability measures. I generalize the existing Inverse Euler Equation and optimal static labor tax formulae and provide a unified intuition based on a set of perturbations around the optimal allocations that preserve expected utility and incentive compatibility. Non-separability in preferences gives rise to a new tradeoff between current and future redistribution that is internalized by the planner's solution but not by private savings decisions. This leads to a novel rationale to subsidize (tax) savings and make labor taxes more (less) persistent, when more productive agents also have higher (lower) consumption needs.