Optimal Income Taxation and Public-Goods Provision with Preference and Productivity Shocks

We study how an optimal income tax and an optimal public-goods provision rule respond to preference and productivity shocks. A conventional Mirrleesian treatment is shown to provoke manipulations of the policy mechanism by individuals with similar interests. We therefore extend the Mirrleesian model so as to include a requirement of coalition-proofness. The main results are the following: first, the possibility of preference shocks yields a new set of collective incentive constraints. Productivity shocks have no such implication. Second, the optimal policy gives rise to a positive correlation between the public-goods provision level, the extent of redistribution and marginal tax rates.