Working Paper: NBER ID: w17035
Authors: Casey Rothschild; Florian Scheuer
Abstract: Recent policy proposals have suggested taxing top incomes at very high rates on the grounds that some or all of the highest wage earners are engaged in socially unproductive or counterproductive activities, such as externality imposing speculation in the financial sector. To address this, we provide a model in which agents can choose between working in a traditional sector, where private and social products coincide, and a crowdable rent-seeking sector, where some or all of earned income reflects the capture of pre-existing output rather than increased production. We characterize Pareto optimal linear and non-linear income tax systems under the assumption that the social planner cannot or does not observe whether any given individual is a traditional worker or a rent-seeker. We find that optimal marginal taxes on the highest wage earners can remain remarkably modest even if all high earners are socially unproductive rent-seekers and the government has a strong intrinsic desire for progressive redistribution. Intuitively, taxing their effort at a lower rate stimulates their rent-seeking efforts, thereby keeping private returns for other potential rent-seekers low and discouraging further entry.
Keywords: optimal taxation; rent-seeking; income tax; progressive taxation
JEL Codes: D3; D5; D8; E2; E6; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rent-seeking behavior (D72) | optimal tax rates (H21) |
| presence of rent-seeking (D72) | Pareto optimal tax rates (H21) |
| taxing top earners at lower rates (H29) | total rent-seeking effort (D72) |
| total rent-seeking effort (D72) | private returns (G19) |
| total rent-seeking effort (D72) | entry into rent-seeking sector (D72) |