Optimal Taxation over the Life Cycle

We derive the optimal labor income tax schedule for a life cycle model with deterministic productivity variation and complete asset markets. An individual chooses whether and how much to work at each date. The government must finance a given expenditure and does not have access to lump sum taxation. We develop a solution method that combines incentive constraints into a single implementability constraint. The average tax rate determines when an individual will work while the marginal tax rate determines how much she will work. The optimal tax schedule has an increasing average tax rate at low levels of income to encourage labor market participation, even in the absence of redistributive concerns. In contrast to the Mirrleesian optimal taxation literature, the marginal tax rate at the top is strictly positive