Equity and Effectiveness of Optimal Taxation in Contests Under an All-Pay Auction

Abstract

The means of contest design may include differential taxation of the prize. This paper establishes that, given a revenue-maximizing contest designer who faces a balanced-budget constraint, the optimal taxation scheme corresponding to an all-pay auction is appealing in two senses. First, it ensures exceptional equitable final prize valuations. Second, it is effective; it yields total contestants’ efforts that are larger than those obtained under almost any Tullock-type lottery. Furthermore, when a budget surplus is allowed, the superiority of optimal taxation under the APA is preserved in terms of equity and effectiveness relative to optimal taxation under any contest success function.

Keywords: contest design, revenue maximization, balanced-budget constraint, budget surplus, optimal differential taxation, endogenous stakes, all-pay auction, lottery

JEL Classification: D700, D720, D740, D780