Summary: We analyze optimal income taxes with deductions for work-related or consumptive goods. We consider two cases. In the first case (called a complex tax system) the tax authorities can exactly distinguish between consumptive and work-related expenditures. In the second case (called a simple tax system) this distinction is not exact. Assuming additively separable utility functions, we show that work-related expenditures should be fully deductible in the first case while deduction rates should be less than 100 percent in the second case. Under further simplifying assumptions, we also show that the simple system can be characterized by higher tax burdens on low income earners and less redistribution.
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