A new National Bureau of Economic Research paper (gated, $5.00) by Casey Rothschild of Middlebury and Florian Scheuer of Stanford looks at the consequences of various tax rates for people with the very highest incomes, assuming that a lot of those people are doing socially unproductive or counterproductive sorts of work – rent-seeking. Paul Krugman and others have suggested rates of 80% or higher on such social parasites – assuming we know who they are.
Rothchild and Scheuer model a moralistic PC economy where Krugman is king, which taxes rent-seekers at 80%, and which seeks to extract maximum revenue from high earners for the purposes of redistribution. What happens is surprising to those who believe that while incentives work, people answer to a higher authority.
Confronted with ultra-high tax rates, the model’s rent-seekers, rationally, work less – which creates more opportunities in the rent-seeking game for productive workers. The loss of productive work, and of tax revenue from higher earnings, offsets the social value of discouraging existing rent-seekers and the tax revenue from “successful” rent-seeking. (Though Rothschild and Scheurer don’t say so, one can imagine a scenario in which the rent-seeking sector becomes “over-heated,” drawing talent and resources away from more productive parts of the economy, and producing very little taxable income).
The result is that even if the Krugmanian government wants to discourage such activities, and it wants to follow a highly redistributive policy, the optimum marginal taxes on the highest wages are remarkably modest – so modest they would send President Krugman into a deep pout. It seems that a low-tax rate for super-rich earners stimulates their rent-seeking efforts, which has the laudatory effect of discouraging further entry into the sector by other potential rent seekers, since they will conclude that their potential returns will be low. According to the authors, the optimal tax rates for rent-seeking parasites may be as low as 45% (assuming we know who they are, which we don’t), and for the very richest, as low as 30%.
It seems that President Obama’s fairness test doesn’t work for anyone – except to expanding the pool of people who are incentivized – sorry, inspired– to do unproductive work!
Here is the Abstract from NBER - Optimal Taxation with Rent-Seeking (abstract is free – paper requires subscription or payment).