Progressive Income Tax and Comparative Advantage in Trade

Abstract

We show in the world trade data that countries with more progressive personal income tax system are less likely to have comparative advantage in industris that employ a greater share of high-income occupations, such as high tech and professional service sectors. Moreover, when countries increase their income tax progressivity over time, they further lose comparative advantage in sectors that use high-paying occupations intensively. We propose two theoretical mechanisms to explain these empirical observations: one is the occupational choice model based on the trade-o¤ between the wage and the hours worked in the Heckscher-Ohlin framework; the other is the Heckscher-Ohlin model with international immigration of skilled workers. Both models demonstrate that progressive income tax pushes workers away from high-income long- hours occupations and undermines the comparative advantage in industries that rely heavily on these occupations.

Keywords: Comparative advantage of trade, progressive income tax, occupational choice, immigration

JEL Classification: E2, E6, F10, F22, H24, J24