TAGGING AND TAXING - THE OPTIMAL USE OF CATEGORICAL AND INCOME INFORMATION IN DESIGNING TAX TRANSFER SCHEMES/

This paper explores aspects of the optimal design of tax/transfer sche mes that involve elements of both 'tagging' (the use of categorical be nefits) and 'means-testing' (income-relation of benefits). Simulations suggest a striking qualitative dissimilarity between the group-specif ic schedules optimally imposed on poorer and richer groups: broadly sp eaking, the optimal marginal tax rate is decreasing in income among th e latter but increasing among the former. This latter observation, pot entially important for policy, runs counter to the conventional wisdom from previous simulations. The reconciliation, we argue, lies in the role played in optimal tax design by the revenue constraint.