Mark Huggett
Wenlan Luo

We derive an optimal labor income tax rate formula for urban models that nests the Mirrlees model as a limiting case. Optimal tax rates are determined by traditional forces plus a new term arising from urban forces: house price, migration and agglomeration effects. Based on the earnings distribution, housing costs and housing tenure in large and small US cities, we find that in a benchmark model (i) the optimal income tax rate schedule is U-shaped, (ii) urban forces raise the optimal tax rate schedule at all income levels and (iii) adopting an optimal tax system induces agents with low skill levels to leave large, productive cities.

Publication Type
Working Paper
File Description
First version, August 24, 2023
JEL Codes
J10: Demographic Economics: General
H20: Taxation, Subsidies, and Revenue: General
R20: Household Analysis--General
urban economics
optimal taxation
income inequality