NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Optimal Two-Bracket Linear Income Tax

Joel Slemrod, Shlomo Yitzhaki, Joram Mayshar

NBER Working Paper No. 3847
Issued in September 1991
NBER Program(s):   PE

We investigate the optimal rate structure of an income tax system that is constrained to have only two brackets, plus a demogrant. We find that, in a two-class economy, Pareto efficient tax schedules feature at least one marginal tax rate equal to zero, and that the marginal tax rate may be increasing or declining. We next use numerical optimization techniques to study the optimal structure of such a tax system in a multi-person model that is a stylized version of an actual economy. We discover that in all cases the tax rate in the second (higher) bracket is less than the tax rate that applies to the first bracket but that progressivity, in the sense of a uniformly rising average tax rate, generally obtains. Compared to the optimal one-bracket (linear) tax system, both the highest and lowest income individuals are better off, while a middle range of taxpayers is worse off.

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Document Object Identifier (DOI): 10.3386/w3847

Published: Journal of Public Economics, Vol. 53, no. 2 (February 1994): 269-290.

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