Optimal taxation of top labor incomes
Subtitle: a tale of three elasticities
By: Thomas Piketty, Emmanuel Saez, Stefanie Stantcheva
Contributors: Saez, Emmanuel; Stantcheva, Stefanie; National Bureau of Economic Research
Series: NBER working paper series -- working paper 17616; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 17616.
Publisher: National Bureau of Economic Research
Published: 2011
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "This paper analyzes the problem of optimal taxation of top labor 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, implyingthat 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"--National Bureau of Economic Research web site.
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