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The Optimal Asymptotic Income Tax Rate

This paper shows that a policy maker needs only two types of information to set the optimal income tax rate at the top: the compensated elasticity of labor supply and the shape of income distribution. Unlike recent results in the literature our paper shows that income effects are immaterial for the optimal asymptotic tax rate while the degree of non-linearity of the utility of consumption does play a role in determining the asymptotic rate. By using empirically plausible estimates for the compensated labor supply elasticity and the shape of income distribution, we find that the optimal marginal tax rate at the top should be relatively high, which is in line with the existing rates in the real world.