Optimal Taxation under Regional Inequality

Combining an intensive labor supply margin with an extensive, productivity-enhancing migration margin, we determine how regional inequality and labor mobility shape optimal redistribution. We propose the use of delayed optimal-control techniques to obtain optimal tax formulae with location-dependent productivity and multi-dimensional<br>heterogeneity. Productivity-enhancing inter-regional migration exerts a downward pressure on marginal tax rates. Allowing for regionally differentiated taxation with location-dependent productivity, we find that marginal tax rates in high- (low-)productivity regions should be corrected downwards (upwards). Simulations using the productivity differences between metropolitan and other regions in the US indicate that productivity-increasing internal migration constitutes only a minor<br>constraint on regionally undifferentiated redistributive taxation, but it is quantitatively more important for differentiated taxation.<br><br>