Demand for 'The 1%':Tax Incidence and Implications for Optimal Income Tax Rates

Abstract

We develop a model for determining the optimal high income linear tax rate when there exist imperfectly substitutable types of labor. If one type is disproportionately prevalent among higher income taxpayers, then wages adjust in response to more progressive taxation and part of the statutory tax burden is shifted to lower income taxpayers. Our derivation is expressed in terms of readily interpretable elasticity and income distribution parameters which we use to estimate the optimal top tax rate under various plausible alternatives. We reject the notion from the previous literature that wage adjustments are costly enough (from a social welfare perspective) to warrant non-progressive taxation, much less subsidization of high income taxpayers. However, we also estimate that the optimal tax rate may be significantly smaller than when incidence effects are ignored, and may in fact be quite similar to current rates under U.S. policy.

Nonlinear Tax Incidence and Optimal Taxation in General Equilibrium

“…See alsoGreen and Phillips (2015) who study quantitatively the size of the optimal top tax rate in a two-sector model.41 Note that this "partial equilibrium" formula is computed given the wage distribution at the optimum general equilibrium tax schedule.…”