Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities

By Thomas Piketty, Emmanuel Saez, Stefanie Stantcheva. 2011

833 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Gender Studies

View Paper: https://www.semanticscholar.org/paper/9ad9e64efd91573a2bcee47a53f698a916539cc4

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Citations in the corpus

Labor Unions, Political Representation, and Economic Inequality (2017, background): “Unions’ political activities may lead to higher income tax rates that discourage very high pay (Piketty et al. 2014).”
Taxation and Innovation in the 20th Century (2018, neutral): “reported income (Kleven and Waseem, 2013; Saez, 2010), rent-seeking (Piketty et al., 2014), or charitable contributions (Fack and Landais, 2010).”
How Can Scandinavians Tax So Much (2014, background): “The data on the top marginal income tax rates (source: Piketty, Saez, and Stantcheva 2014) are from 2011 for Germany and from 2010 for the other five countries.”
Income inequality and health: a causal review. (2015, background): “…since the 1970s has led not only to a widening of income differences after tax but, more surprisingly, to a more rapid rise in pre-tax incomes at the top e particularly in the private sector where CEO pay seems unrelated to company performance (Chemi, 2014; Piketty et al., 2011; Tosi et al., 2000).”
Understanding Tax Policy: How Do People Reason? (2020, background): “Regarding earnings responses at the top, the evidence suggests that they are indeed a mix of effects that include avoidance or evasion (Piketty et al., 2014; Saez et al., 2012).”
Artificial Intelligence and Its Implications for Income Distribution and Unemployment (2017, neutral): “See Piketty et al. (2014) and Stiglitz (2017). The points that we have denoted Eo and E1 describe the initial outcome and the outcome after-technological change, assuming that laws, regulations, institutions, etc.”
Bankers and Their Bonuses (2014, positive): “Piketty et al. (2011) examine time-series evidence across 18 OECD countries and show that”