Regional productivity di¤erences are large and provide scope for productivity- enhancing inter-regional labor mobility. Using an optimal taxation framework that combines an intensive labor supply margin with an extensive, productivity- enhancing migration margin, we explore the implications of regional productivity diferences for the design of optimal tax transfer-schemes. Regional inequality poses an additional restriction on the government which can limit optimal redistribution. With intra-regional migration marginal tax rates tend to be reduced and negative tax rates are possible. Our simulations indicate that the additional restriction can be quantitatively important and that negative tax rates can occur for empirically plausible cases.

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