Optimal labor income taxation with the dividend effect

Abstract

The unequal distribution of dividends implies the unequal distribution of the profit share of workers’ product of labor. In a Mirrleesian framework when dividends cannot be expropriated, we show that a progressive distribution of dividends creates a positive dividend effect on labor income taxes. Our numerical simulations show the dividend effect to be approximately four percentage points. We analyze the dividend effect under different market structures and its interplay with other forms of taxation.