Hellwig, Christian (2021) Static and Dynamic Mirrleesian Taxation with Non-separable Preferences: A Unified Approach. TSE Working Paper, n. 21-1224, Toulouse

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Abstract

I analyze dynamic Mirrlees taxation with preferences that are non-separable between con-
sumption, leisure and type, which determines both ability and consumption needs. I show how
to account for non-separable preferences through a simple change in probability measures. I ge-
neralize the existing Inverse Euler Equation and optimal static labor tax formulae and provide
a unied intuition based on a set of perturbations around the optimal allocations that preserve
expected utility and incentive compatibility. Non-separability in preferences gives rise to a new
tradeo between current and future redistribution that is internalized by the planner's solution
but not by private savings decisions. This leads to a novel rationale to subsidize (tax) savings
and make labor taxes more (less) persistent, when more productive agents also have higher
(lower) consumption needs.