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Mirrlees Meets Laibson: Optimal Income Taxation With Bounded Rationality

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Executive Summary

This paper studies an optimal taxation problem in a dynamic economy inhabited by individuals who differ in productivity (as in Kocherlakota, 2006) and in the short-term discount factor. The authors determine incentive compatible Pareto optimal allocations in a multidimensional screening model where individuals have to report truthfully their types. Two forms of bounded rationality are considered: in the first one, some individuals discount future payoffs at a higher rate than others (myopia). In this application, the planner respects consumers' sovereignty, and maximizes a Paretian social welfare function. In the second application, some individuals are time inconsistent: they systematically change future plans and regret ex-post for the lack of commitment power.

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