Implementing Optimal Taxation: A Constrained Optimization Framework for Tax Reform

Paper: arXiv 2508.03708

Authors: Mark Verhagen, Menno Schellekens, Michael Garstka

Abstract

While optimal taxation theory provides clear prescriptions for tax design, translating these insights into actual tax codes remains difficult. Existing work largely offers theoretical characterizations of optimal systems, while practical implementation methods are scarce. Bridging this gap involves designing tax rules that meet theoretical goals, while accommodating administrative, distributional, and other practical constraints that arise in real-world reform. We develop a method casting tax reform as a constrained optimization problem by parametrizing the entire income tax code as a set of piecewise linear functions mapping tax-relevant inputs into liabilities and marginal rates. This allows users to impose constraints on marginal rate schedules, limits on income swings, and objectives like revenue neutrality, efficiency, simplicity, or distributional fairness that reflect both theoretical and practical considerations. The framework is computationally tractable for complex tax codes and flexible enough to accommodate diverse constraints, welfare objectives and behavioral responses. Whereas existing tools are typically used for ex-post `what-if’ analysis of specific reforms, our framework explicitly incorporates real-world reform constraints and jointly optimizes across the full tax code. We illustrate the framework in several simulated settings, including a detailed reconstruction of the Dutch income tax system. For the Dutch case, we generate a family of reforms that smooth existing spikes in marginal tax rates to any desired cap, reduce the number of rules, and impose hard caps on income losses households can experience from the reform. We also introduce \texttt{TaxSolver}, an open-source package, allowing policymakers and researchers to implement and extend the framework.

Complexity vs Empirical Score

• Math Complexity: 5.5/10
• Empirical Rigor: 6.5/10
• Quadrant: Holy Grail — high math complexity, high empirical rigor

Why this score: The paper provides an innovative computational approach to public finance by framing statutory tax code reform as a constrained optimization problem. It balances solid formalization with strong real-world applicability, demonstrated via a detailed reconstruction of the Dutch tax system and an open-source software release.

Research Flowchart

  flowchart TD
    A["Research Goal: Bridge theory & practice by framing tax reform as constrained optimization"] --> B["Inputs: Tax-relevant data, welfare objectives, behavioral responses & practical constraints"]
    B --> C["Parametrize Tax Code: Map liabilities & marginal rates using piecewise linear functions"]
    C --> D["Computational Engine: Jointly optimize full tax code via TaxSolver package"]
    D --> E["Findings: Successfully smoothed Dutch MTR spikes, simplified rules & capped household income losses"]

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0 of 122 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.