Taxing the Job Creators : Efficient Progressive Taxation with Wage Bargaining

The standard economic view of the personal income tax is that it is a distortionary way of raising revenue which nonetheless has value because of its desirable effects on the distribution of income. However, when wages deviate from marginal product, the laissez-faire (no-tax) equilibrium is inefficient, which can create an independent efficiency rationale for income taxation. I study a setting of wage bargaining within hierarchical teams, and show that the efficiency case for taxing managers depends on a "job-creation" effect: if wages are too low and increased labour supply allows managers to supervise larger teams and thus collect larger rents, they will have an incentive to devote an inefficiently high amount of effort to creating jobs at their firm. It may then be efficient to tax the "job creators" because of their job-creation activity. Simulation of a calibrated model suggests an efficient tax schedule that is progressive over most of the income distribution with a top marginal rate of between 50% and 60%. For a planner with redistributive motives, optimal marginal tax rates are also considerably higher at the top of the distribution in the presence of wage bargaining