RANDOMIZATION IN OPTIMAL INCOME-TAX SCHEDULES

The optimal income tax problem is one of many problems in economics for which a randomized allocation may be desirable. For a two-class economy, we characterize optimal random tax schedules and present necessary and sufficient conditions for local randomization either to be Pareto improving or to extend the constrained Pareto frontier. We present another sufficient condition for nonlocal randomization to be Pareto improving, which need not violate ex post or ex ante horizontal equity. Lastly, an example demonstrates that the gains from randomization may be large.