Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium

We study the incidence of nonlinear labor income taxes in an economy with a continuum of endogenous wages. We derive in closed form the effects reforming nonlinearly an arbitrary tax system, by showing that this problem can be formalized as an integral equation. Our tax incidence formulas are valid both when the underlying assignment of skills to tasks is fixed or endogenous. We show qualitatively and quantitatively that contrary to conventional wisdom, if the tax system is initially suboptimal and progressive, the general-equilibrium "trickle-down" forces may raise the benefits increasing the marginal tax rates on high incomes. We finally derive a parsimonious characterization of optimal taxes.