| Arie Beresteanu, Northwestern University Dahan Momi, Ministry of Finance, Israel |
| An Optimal Shape of Income Tax: Evidence from Zero Income Tax Countries - Paraguay and Uruguay |
| Session: C-12-14 Wednesday 16 August 2000 by Beresteanu, Arie |
| In this paper we use empirical evidence to address the question of optimal taxation. Almost all attempts that have been made to investigate the shape of optimal income tax have a common result: the optimal marginal tax schedule is decreasing with income, which stands in sharp contrast with real world income tax systems. Recent work by Dahan and Strawczynski (2000) shows that this result is sensitive to the underlying distribution of ability. In this paper we attempt to determine empirically the shape of the distribution to assess how the optimal tax schedule should look like. We use household surveys from Paraguay and Uruguay to estimate the distribution of ability. Those two countries have zero income tax and therefore the observed hourly wage is a good proxy for ability, not distorted by taxes. We estimate the hazard rate function of the ability distribution using non-parametric estimation method, which is free of any functional assumptions on the underlying distribution of ability. The hourly wage distribution in Paraguay and Uruguay has a very long tail and a careful estimation procedure of the hazard rate is suggested. We find that progressive taxation is optimal based on efficiency grounds as well as remedy for inequality. |