A Fair Day's Pay for a Fair Day's Work: Optimal Tax Design as Redistributional Arbitrage

We study optimal tax design based on the idea that policy-makers face trade-offs between multiple margins of redistribution. Within a Mirrleesian economy with earnings, consumption and retirement savings, we derive a novel formula for optimal non-linear income and savings distortions based on redistributional arbitrage. We establish a sufficient statistics representation of the labor income and capital tax rates on top income earners, which relies on the comparison between the Pareto tails of income and consumption. Because consumption is more evenly distributed than income, it is optimal to shift a substantial fraction of the top earners' tax burden from income to savings. Our results extend to economies with one-dimensional heterogeneity and general preferences over an arbitrary set of commodities.

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