Optimal Taxation with Rent-Seeking

61 Pages Posted: 9 May 2011 Last revised: 20 Jul 2023

See all articles by Casey Rothschild

Casey Rothschild

Wellesley College

Florian Scheuer

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: May 2011

Abstract

Recent policy proposals have suggested taxing top incomes at very high rates on the grounds that some or all of the highest wage earners are engaged in socially unproductive or counterproductive activities, such as externality imposing speculation in the financial sector. To address this, we provide a model in which agents can choose between working in a traditional sector, where private and social products coincide, and a crowdable rent-seeking sector, where some or all of earned income reflects the capture of pre-existing output rather than increased production. We characterize Pareto optimal linear and non-linear income tax systems under the assumption that the social planner cannot or does not observe whether any given individual is a traditional worker or a rent-seeker. We find that optimal marginal taxes on the highest wage earners can remain remarkably modest even if all high earners are socially unproductive rent-seekers and the government has a strong intrinsic desire for progressive redistribution. Intuitively, taxing their effort at a lower rate stimulates their rent-seeking efforts, thereby keeping private returns for other potential rent-seekers low and discouraging further entry.

Suggested Citation

Rothschild, Casey and Scheuer, Florian, Optimal Taxation with Rent-Seeking (May 2011). NBER Working Paper No. w17035, Available at SSRN: https://ssrn.com/abstract=1833171

Casey Rothschild (Contact Author)

Wellesley College ( email )

106 Central St.
Wellesley, MA 02181
United States

Florian Scheuer

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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