Part 1 - AL-Tax

International Taxation Handbookσ 1σ 2ZA~σFigure 4.1Rawlsian governmentsProposition 2.properties:At equilibrium, the optimal allocations have the following● If σ2 ∈ [ σ ɶ, [,the incentive constraint (4.2) is binding: The labor supplyof the skilled worker is not distorted while the labor supply of theunskilled worker is distorted. Each skilled worker pays a total income taxsmaller than σ 2 .● If σ2∈ [ 0, σɶ[, none of the incentive constraints is binding, so labor suppliesare not distorted. Each skilled worker pays a total income tax equal to σ 2 .● For any given σ 2 , the tax policy does not depend on σ 1 .The proposition can be summarized by Figure 4.1.There are two regimes of taxation, depending the value of σ 2 . If σ 2 is small, taxpolicy does not involve any distortion (Area ZA in Figure 4.1). On the contrary,if σ 2 is large enough, the tax polices are less redistributive but qualitatively similarto the tax policy in autarky.This result recalls that of Rochet and Stole (2002), but the framework and theintuition are quite different. A government has three relevant constraints here.First, it must respect a budget constraint. Second, the government has to leaveenough rent to skilled workers in order to dissuade them from misreporting theirtype, which is formalized by the incentive constraint (4.2). But here the governmentalso has to prevent migration of the skilled workers (which is new comparedto the autarky case).If σ 2 is small, moving from one country to the other is quite easy, then the thirdconstraint prevails: In order to prevent migration, sufficient rent is given toskilled workers and they have no incentive to misreport their type. If σ 2 becomes84