Pavel Doligalski (Bristol), 09.11.2022

Half of the jobs in the U.S. feature pay-for-performance. We derive
novel incidence and optimum formulas for the overall rate of tax
progressivity and the top tax rates when such labor contracts arise
from moral hazard frictions within firms. Optimal taxes account for
the fiscal externalities and welfare consequences of two distinct
forces: a direct crowding-out of private insurance and a
countervailing crowding-in due to endogenous labor effort
responses. These imply that the amount of pre-tax earnings risk to
which the worker is exposed is roughly invariant to tax progressivity,
whereas the (adverse) welfare consequences of the crowd-out
outweigh those of the crowd-in, leading to lower optimal tax
progressivity.
Coauthors: A. Ndiaye and N. Werquin