We study optimal fiscal policy to address climate change and inequality. We theoretically characterize optimal carbon and income taxes, and quantify them for the US economy with the climate model calibrated to DICE. In contrast to the representative-agent setting, we find that (i) tax distortions have a negligible effect on the optimal carbon tax; (ii) inequality only slightly reduces it; (iii) the revenue from carbon taxes is optimally split halfway between reducing tax distortions and increasing transfers. Unlike the double-dividend policy, optimal carbon taxation has progressive welfare effects and low-income households benefit even in the short run.

JEL classification: E62, H21, H23, Q5
Keywords: climate policy, carbon taxes, social cost of carbon, optimal taxation, double dividend, heterogeneous agents, redistribution.

In a Mirrleesian environment, a monopsonist sets hourly wages and individuals choose how many hours to work. Labor market outcomes do not only depend on the level and slope of the income tax function, but also on its curvature. A more concave tax schedule raises the elasticity of labor supply, which boosts wages. Consequently, optimal marginal tax rates for low-skilled workers are declining in income. I derive an optimal tax formula in terms of sufficient statistics that accounts for the impact of tax curvature on labor market outcomes. Numerical simulations suggest that optimal marginal tax rates are rapidly declining at low incomes, and negative for most individuals.

JEL classification: H21, J38, J42
Keywords: monopsony, optimal taxation, tax curvature

The Atkinson-Stiglitz theorem on uniform consumption taxation breaks down if prices are endogenous. This paper investigates the implications for optimal food subsidies in China. To do so, we build a general equilibrium model where low-skilled workers have a comparative advantage in the production of food. Food subsidies raise the relative demand for low-skilled workers, which reduces the skill premium and indirectly redistributes income from high-skilled to low-skilled workers. The optimal food subsidy balances these distributional gains against the costs of distorting consumption decisions. We calibrate our model to match key moments from the Chinese economy, including sectoral production and spending patterns that we obtain from micro-level survey data. Our results suggest that general equilibrium effects rationalize only very modest food subsidies that generate tiny welfare gains.

JEL classification: E64, H21, Q18.
Keywords: uniform consumption taxes, general equilibrium effects, food subsidies

This paper studies the implications of monopsony power for optimal income taxation and welfare. Firms observe workers’ abilities while the government does not and monopsony power determines what share of the labor market surplus is translated into profits. Monopsony power increases the tax incidence that falls on firms. This makes labor income taxes less (more) effective in redistributing labor income (profits). The optimal tax schedule is less progressive. Monopsony power alleviates the equity-efficiency trade-off that occurs because the government does not observe ability, but at the expense of exacerbating capital income inequality. I illustrate these findings for the US economy.

JEL classification: H21, H22, J42, J48
Keywords: monopsony, optimal taxation, tax incidence

This paper studies optimal income taxation in an environment where matching frictions generate a trade-off for workers between high wages and low unemployment risk. A higher marginal tax rate shifts the trade-off in favor of low unemployment risk, whereas a higher tax burden or unemployment benefit has the opposite effect. Changes in unemployment generate fiscal externalities, which modify optimal tax formulas. I show that optimal employment subsidies (such as the EITC) phase in with income and that the provision of unemployment insurance justifies a positive marginal tax rate even without income heterogeneity. A calibration exercise to the US economy suggests that optimal transfers for low-income individuals are larger if unemployment risk is taken into account.

JEL classification: H21, J64, J65, J68
Keywords: directed search, optimal taxation

This paper extends the Diamond (1980) model with labor unions to study optimal income taxation and to analyze whether unions can be desirable for income redistribution if income taxes are optimized. Unions bargain with firms over wages in each sector and firms unilaterally determine employment. Optimal unemployment benefits and optimal income taxes are lower in unionized labor markets. Unions raise the efficiency costs of income redistribution, because unemployment benefits and income taxes raise wage demands and thereby generate involuntary unemployment. We show that unions are socially desirable only if they represent (low-income) workers whose participation is subsidized on a net basis. By creating implicit taxes on work, unions alleviate the labor-market distortions caused by income taxation. We empirically verify whether i) participation tax rates are lower if unions are more powerful, and ii) unions are desirable by compiling our own data set with union densities and participation tax rates for 18 sectors in 23 advanced countries. In line with our theoretical predictions, we find that participation tax rates are lower if unions are stronger. Moreover, the desirability condition for unions is never met empirically. Numerical simulations for the Netherlands confirm that unions are not desirable if income taxes are optimized and optimal participation taxes are lower if unions are stronger.

JEL classification: H21, H23, J51, J58
Keywords: optimal taxation, unions, wage bargaining, labor participation