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 multidimensional heterogeneity. Productivity-enhancing interregional migration exerts a downward pressure on marginal tax rates. Allowing for regionally differentiated taxation with location-dependent productivity, we nd that marginal tax rates in high-(low-)productivity regions should be corrected downwards (upwards). Simula- tions using the productivity differences between metropolitan and other regions in the US indicate that productivity-increasing internal migration constitutes only a minor constraint on regionally undifferentiated redistributive taxation, but it is quantitatively more important for differentiated taxation.