Real-world tax legislation assigns goods to different categories of tax rates on the basis of observable characteristics, allowing the tax system to handle a constantly evolving set of available goods. We recast the theory of optimal taxation in the language of characteristics, and we show how to optimally draw lines that delineate tax-rate regimes. Such lines are associated with notches in tax liability as a function of characteristics, creating incentives to introduce goods with new combinations of characteristics in order to reduce tax liability. With a restricted set of tax instruments, such notches are in general part of the second-best optimal tax system.

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1 April 2017

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The Scandinavian Journal of Economics 119(2) , pp.240-267, 2017

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DOI: 10.1111/sjoe.12174

https://onlinelibrary.wiley.com/doi/abs/10.1111/sjoe.12174

This Journal article is published under the centre's Growth programme.