Optimal income taxation and public-good provision with endogenous interest groups

We study how an optimal income tax and an optimal public-goods provision rule respond to preference and productivity shocks. It is shown that a conventional Mirrleesian treatment of this problem will provoke manipulations of the policy mechanism by individuals with sim-ilar interests. We therefore extend the Mirrleesian model so as to include collective incentive compatibility constraints. As a main result, it is shown that an optimal policy mechanism which respects these constraints gives rise to a positive correlation between the public-goods provision level, the extent of redistribution and marginal income tax rates