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Taxes and the Efficiency‐Rent Extraction Trade‐off

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  • ANIL ARYA
  • JONATHAN GLOVER
  • BRIAN MITTENDORF

Abstract

This paper presents an adverse selection model in which progressive taxation enhances productive efficiency by encouraging a principal (buyer) to be less aggressive in contracting with an agent (seller). Wary of padded cost budgets, the buyer employs a hurdle‐rate procurement policy. With a low cost hurdle, the buyer keeps greater profits when transactions are undertaken but trade occurs less often. While the hurdle is unaffected by a flat tax, a progressive tax tilts the buyer's preference: the buyer's benefit from a lower hurdle becomes less pronounced, since the marginal increase in his profits is muted in after‐tax terms. The result is increased trade and the possibility of Pareto improvements.

Suggested Citation

  • Anil Arya & Jonathan Glover & Brian Mittendorf, 2006. "Taxes and the Efficiency‐Rent Extraction Trade‐off," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(5), pages 741-760, December.
    • Handle: RePEc:bla:jpbect:v:8:y:2006:i:5:p:741-760
    DOI: 10.1111/j.1467-9779.2006.00286.x
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    Cited by:

    1. Anil Arya & Brian Mittendorf, 2011. "The interaction between corporate tax structure and disclosure policy," Annals of Finance, Springer, vol. 7(4), pages 511-527, November.

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