Comparing Optimum Non-linear Income Taxation with Optimum Linear Income Taxation

Abstract

As Income tax regime changes, the welfare levels of different types of Individuals also change. This paper studies the welfare change of individuals with different abilities under different income tax regimes: the non-linear Income tax system and the linear Income tax system. Overall level of social welfare is enhanced in the non-linear system. Though the marginal tax on the high ability people is zero under non-linear income taxation, the simulation results show that high ability type is worse off under reasonable estimates of elasticity of substitution between consumption and leisure. The low and middle ability types are better off under the non-linear system. When the elasticity of substitution is low, non-linear income taxation is Pareto-superior. It makes all types of Individuals better off than linear Income taxation.