Optimal Taxation and Wealth Redistribution

As a model for optimal taxation, we consider a society with homogeneous preferences but unequal incomes. The redistribution of income from high earners to low earners then increases the overall utility derived from the... [ view full abstract ]

As a model for optimal taxation, we consider a society with homogeneous preferences but unequal incomes. The redistribution of income from high earners to low earners then increases the overall utility derived from the overall income. The optimal tax is defined as that which equalizes income after redistribution, subject to the condition that the overall utility is unchanged. We show that the problem of optimal taxation is mathematically equivalent to that of the extraction of the maximal amount of energy from a thermostatic system by quasi-static processes: in short, the problem of constructing an ideal heat engine.