Taxes and Rents: The Power of Tax Policy to Shape the Distribution of Pre-Tax Income

Abstract

Much of the legal academic tax policy analysis of the last 40 years inhabits the “classical optimal tax framework,” in which desires for government spending and redistribution are balanced against the theoretical economic costs of high tax rates. While this analytic frame can be useful, it has historically been anchored to antiquated assumptions that are contrary to modern economic research. The result has been a literature that overemphasizes the theoretical economic costs of taxation, while radically underestimating the role of taxes in regulating economic inequality. This article brings together recent advances in the economics literature with evidence from other disciplines to make the case that, rather than discouraging productive activity, progressive tax rates may instead discourage rent-seeking behaviors by high-income workers, leaving more compensation on the table for lower-income workers to share. In this way, progressive tax policy can be understood not only as redistributing income through direct transfers ex post, but also as regulating the distribution of market income ex ante, with high marginal tax rates reducing market-income inequality, and comparatively low rates encouraging the upward redistribution of resources. The article situates these insights within the broader tax literature and demonstrates their profound ramifications for multiple areas of tax scholarship.