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Journal article
A Characteristics Approach to Optimal Taxation: Line Drawing and Tax-Driven Product Innovation
Christian Gillitzer, Henrik Kleven and Joel Slemrod April 2017
Paper No' :

JEL Classification: H21

Tags: productivity; notches; tax design

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.