This paper analyses optimal income taxation as a trade-off between the incentive effects of increased uncertainty and the welfare benefits of social insurance. Greater prudence increases labour supply because of precautionary incentive effects which reduce the progressivity of the optimal income tax schedule. Increased uncertainty increases progressivity of the income tax schedule because of a greater value of social insurance. Optimal tax progressivity depends on the ratio of prudence to risk aversion: when this ratio is high, incentive effects dominate the social insurance effect, leading to declining optimal income tax rates.
Authors
Hamish Low
Research Fellow University of Oxford
Hamish is the James Meade Professor of Economics at the University of Oxford, a Professorial Fellow of Nuffield College and a Research Fellow at IFS.
Daniel Maldoom
Suggested citation
Low, H and Maldoom, D. (2004). 'Optimal taxation, prudence and risk sharing' (2004)
More from IFS
Understand this issue
The £600 billion problem awaiting the next government
podcast
We speak to David Gauke and Giles Wilkes, two experts who have been at the heart of the spending review process.
25 April 2024
Public investment: what you need to know
explainer
Everything you wanted to know about UK public investment but were too afraid to ask – including analysis of Labour and Conservative plans.
25 April 2024
A mess has been made of Child Benefit, and the clear-up operation may not be easy
comment
"Status quos can be hard to change, no matter how incoherent they are." Robert Joyce writes about child benefit in The Telegraph.
29 March 2024
Policy analysis
Recent trends in and the outlook for health-related benefits
report
Recipients of and spending on health-related benefits have risen rapidly since the start of the pandemic, posing a serious challenge for policymakers.
19 April 2024
4.2 million working-age people now claiming health-related benefits, could rise by 30% by the end of the decade
press release
Our new report sheds more light on forecasts for a substantial increase in the number of people claiming health-related benefits in coming years.
19 April 2024
Oil and gas make Scotland’s underlying public finances particularly volatile and uncertain
comment
A fallback in oil and gas prices has hit Scotland’s underlying public finance position this year.
27 March 2024
Academic research
Intertemporal income shifting and the taxation of business owner-managers
journal article
We show that responses of UK company owner-managers to personal taxes are due to intertemporal income shifting and not reductions in business activity
24 January 2024
Insurance, redistribution, and the inequality of lifetime income
working paper
This paper studies how the tax-and-transfer system mitigates income inequalities over the lifetime, which can lead to disparities in living standards.
2 November 2023
The menopause "penalty"
working paper
We estimate the effect of menopause diagnosis on employment and earnings, reliance on social safety net programs, and demand for medical care.
18 March 2024