optimal tax

     

Optimal tax theory is the stuy of how best to design a tax to avoid distortion and inefficiency. Other things being equal, if a tax-payer must choose between two mutually exclusive economic projects (say investments) that face the same pre-tax risk and returns, the one with the lower tax or with a tax break would be chosen by the rational actor. With that insight, economists argue that generally taxes distort behavior. For example, since only economic actors who engage in market activity of "entering the labor market" get an income tax liability on their wages, people who are able to consume leisure or engage in household production outside the market by say providing housewife services in lieu of hiring a maid are more lightly taxed. With the "Married filing jointly" tax unit in American income tax law, the second earner's income is placed on top of the first wage earner's taxable income and thus gets the highest marginal rate. This type of tax creates a large distortion disfavoring women from the labor force during years when the couple have great child care needs.

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