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Top Income Taxation: Efficiency, Social Welfare and the Laffer Curve

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Abstract

This paper develops a comprehensive framework for analyzing the revenue, efficiency and social welfare implications of top income taxation. It generalizes the Saez (2001) formula for the optimal top tax rate by deriving analytical expressions for the Laffer curve and excess burden. Applied to the 2021 U.S. top federal tax bracket, assuming a taxable income elasticity of 0.25, the study finds an excess burden of $101 billion and a maximum potential revenue increase of $111 billion. In contrast, other English-speaking countries and Germany are positioned closer to their Laffer curve peaks, incurring greater efficiency losses, whereas the Nordic countries studied are on the downward-sloping part of the Laffer curve. Additionally, the paper endogenizes the marginal social welfare weight on high-income earners and, following an inverse optimal taxation approach, concludes that in none of the studied countries does the observed top marginal tax rate appear consistent with a conventional welfarist social welfare function.

Suggested Citation

  • Lundberg, Jacob, 2024. "Top Income Taxation: Efficiency, Social Welfare and the Laffer Curve," Working Paper Series 1492, Research Institute of Industrial Economics.
    • Handle: RePEc:hhs:iuiwop:1492
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    References listed on IDEAS

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    1. Herve Moulin, 2004. "Fair Division and Collective Welfare," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262633116, December.
    2. Tuomas Matikka, 2018. "Elasticity of Taxable Income: Evidence from Changes in Municipal Income Tax Rates in Finland," Scandinavian Journal of Economics, Wiley Blackwell, vol. 120(3), pages 943-973, July.
    3. Raj Chetty, 2012. "Bounds on Elasticities With Optimization Frictions: A Synthesis of Micro and Macro Evidence on Labor Supply," Econometrica, Econometric Society, vol. 80(3), pages 969-1018, May.
    4. Guido W. Imbens & Donald B. Rubin & Bruce I. Sacerdote, 2001. "Estimating the Effect of Unearned Income on Labor Earnings, Savings, and Consumption: Evidence from a Survey of Lottery Players," American Economic Review, American Economic Association, vol. 91(4), pages 778-794, September.
    5. Diamond, Peter A, 1998. "Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates," American Economic Review, American Economic Association, vol. 88(1), pages 83-95, March.
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    More about this item

    Keywords

    Income taxation; Optimal taxation; Laffer curve; Excess burden;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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