Working Paper: CEPR ID: DP8675
Authors: Thomas Piketty; Emmanuel Saez; Stefanie Stantcheva
Abstract: This paper analyzes the problem of optimal taxation of top labour incomes. We develop a model where top incomes respond to marginal tax rates through three channels: (1) the standard supply-side channel through reduced economic activity, (2) the tax avoidance channel, (3) the compensation bargaining channel through efforts in influencing own pay setting. We derive the optimal top tax rate formula as a function of the three elasticities corresponding to those three channels of responses. The first elasticity (supply side) is the sole real factor limiting optimal top tax rates. The optimal tax system should be designed to minimize the second elasticity (avoidance) through tax enforcement and tax neutrality across income forms, in which case the second elasticity becomes irrelevant. The optimal top tax rate increases with the third elasticity (bargaining) as bargaining efforts are zero-sum in aggregate. We then analyze top income and top tax rate data in 18 OECD countries. There is a strong correlation between cuts in top tax rates and increases in top 1% income shares since 1975, implying that the overall elasticity is large. But top income share increases have not translated into higher economic growth, consistent with the zero-sum bargaining model. This suggests that the first elasticity is modest in size and that the overall effect comes mostly from the third elasticity. Consequently, socially optimal top tax rates might possibly be much higher than what is commonly assumed.
Keywords: optimal income taxation
JEL Codes: H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| supply-side elasticity (e1) (H32) | optimal top tax rate (H21) |
| tax avoidance elasticity (e2) (H26) | optimal top tax rate (H21) |
| bargaining elasticity (e3) (C79) | optimal top tax rate (H21) |
| cuts in top tax rates (H29) | increases in top income shares (D33) |
| overall elasticity (H30) | optimal top tax rate (H21) |
| first elasticity (e1) (C51) | optimal top tax rate (H21) |
| optimal top tax rate (H21) | socially optimal top tax rates (H21) |