Optimal income taxation under labor interdependence

In this thesis, I consider optimal redistributive income taxation under a Mirrleesian framework while adding utility interdependence over labor choice and analyze whether the optimal tax schedule is regressive or progressive. In this environment, I show that optimal marginal income taxation could be progressive depending on the parameters of the model. There are two separate forces that are at work in determining the optimal tax schedule. First, due to the informational problems, there is a usual Mirrleesian force that works towards the regressivity of taxes. Second effect is a novel force that arises from labor externality and has a progressive effect on the income tax. This effect could be called as Pigouvian tax. Labor externality requires subsidies for agents which are asymmetric according to productivities. Because of this asymmetry, there should be higher subsidies for low types which has a progressive effect on the optimal tax schedule. Pigouvian and Mirrleesian effects are in a multiplicative form in the tax function, therefore the tax schedule is identified by the effect which is more powerful. I also show that, when we consider the labor interdependence, zero tax at the top of the skill distribution result is no longer valid. Additionally, I show that even under full information the market is not efficient and there is a need for progressive income taxes, as there is a need to correct the labor externality. Moreover, the numerical examples of the paper show the progressive effect of labor externality on the tax schedule. This additional concern about labor externality makes the income taxation schedule more consistent with the current tax policies.