Working Paper: CEPR ID: DP10247
Authors: Casey Rothschild; Florian Scheuer
Abstract: We develop a framework for optimal taxation when agents can earn their income both in traditional activities, where private and social products coincide, and in rent-seeking activities, where private returns exceed social returns either because they involve the capture of pre-existing rents or because they reduce the returns to traditional work. We characterize Pareto optimal non-linear taxes when the government does not observe the shares of an individual?s income earned in each of the two activities. We show that the optimal externality correction typically deviates from the Pigouvian correction that would obtain if rent-seeking incomes could be perfectly targeted, even at income levels where all income is from rent-seeking. If rent-seeking externalities primarily affect other rent-seeking activity, then the optimal externality correction lies strictly below the Pigouvian correction. If the externalities fall mainly on the returns to traditional work, the optimal correction strictly exceeds it. We show that this deviation can be quantitatively important.
Keywords: multidimensional screening; rent-seeking; tax policy
JEL Codes: D5; D8; E6; H2; J6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal correction amounts to 53% of the Pigouvian correction (H21) | General equilibrium effects are significant (D59) |
| Income from traditional work and rent-seeking activities (E25) | Optimal taxation strategy must deviate from traditional models (H21) |
| Rent-seeking externalities mainly affect traditional work (D62) | Optimal tax correction exceeds the Pigouvian rate (H21) |
| Rent-seeking externalities mainly affect rent-seeking activities (D62) | Optimal correction is below the Pigouvian rate (H21) |
| Indirect effects of taxation on effort allocation between rent-seeking and productive work (H31) | Determining optimal tax policy (H21) |
| Zero marginal tax rate for certain types of income (H24) | Optimal not to tax rent-seeking income directly (H21) |