The optimal linear taxation of employment and self-employment incomes

This paper models optimal linear taxation when occupational choice and labour supply are endogenous. Workers choose between paid employment, self-employment, and unemployment. Self-employment incomes are risky and employees may be involuntarily laid off. Calibrating the model to the UK economy, the optimal tax solution involves relatively high taxation with substantial redistribution, and a higher nominal (but not effective) marginal tax rate imposed on the self-employed than on employees. The implications of making unemployment benefits as well as tax rates endogenous are also analysed, and robustness checks are performed. (C) 1999 Elsevier Science S.A. All rights reserved.