Part 1 - AL-Tax

International Taxation Handbook4.5 Quasi-utilitarian criterionProposition 2 contrasts with the results obtained by Hindriks (1999). Opposite toour model, his optimal transfer policy depends on the variable σ 1 . This importantdifference does not come from his assumption on information, but from theobjective of the governments. Considering other welfare functions we get optimaltax policies which depend on σ 2 and σ 1 . The following example shows this.Let us consider the case where the government of country B maximizes thesocial welfare:max αU B1 U B2under the incentive constraints (4.1) and (4.2), and the budget constraint (4.4).We keep the same concept of equilibrium, i.e. Nash equilibrium, the revelationprinciple still applies, and because countries are similar, we restrict attention tosymmetric equilibria.Proposition 3.equilibrium:If both governments have a quasi-utilitarian objective, then at● If σ 2 ∉ S ɶ none of the incentive constraints is binding – labor supplies arenot distorted. Each skilled worker pays a total income tax T 2 .● If σ 2 ∈ S ɶ the incentive constraint (4.2) is binding – the labor supply of theskilled worker is not distorted, while the labor supply of the unskilledworkers is distorted. Each skilled worker pays a total income tax smallerthan T 2 .Whereand⎧ɶ⎡ p1σɶ⎤ ⎫S ⎨⎪s 0, 1 s σɶ⎢⎣ αp2 ασ ⎥⎬⎪⎩⎪1⎦⎭⎪T2⎛ p ⎞21 α σ⎝⎜p1⎠⎟p2p2σαp p σ11112.The intuition behind this proposition can be explained using Figure 4.2,which represents the set S ~ .86