Redistributive taxation as social insurance

The modern literature on nonlinear optimal taxation treats differences in income as being due to unobserved differences in ability. A striking result of this assumption is that high income agents should face a zero marginal tax rate. In this paper I assume that differences in observed income are due to exogenous differences in luck. Hence the optimal redistributive tax involves trading off the benefits due to ‘social insurance ’ with the costs due to reduced incentives. I derive the optimal forms for linear and nonlinear taxes, and compute some algebraic and numeric examples. Typically high income individuals will face quite high marginal tax rates. 1