Henrik Kleven, Princeton University, Department of Economics and the School of Public and International Affairs

Externalities and the Taxation of Top Earners

Abstract

The paper characterizes the optimal taxation of top earners in a world with externalities. It takes a reduced-form approach that spans a broad class of models where top earners create externalities on the economy. The model allows for a flexible relationship between top earnings and the distribution of earnings capacities in the population, including positive externalities (such as innovation) and negative externalities (such as rent-extraction). The model allows for simple optimal tax formulas that clarify the role of different externality patterns. In general, externalities that run from top earners to bottom earners have much stronger tax implications than externalities within the top group. The results are expressed in terms of estimable sufficient statistics and linked to recent evidence on the externalities of top entrepreneurs. A calibration to the US economy suggests that the optimal top tax rate, while lower than the Mirrleesian optimum, remains higher than the current top tax rate.

Henrik Kleven is the Lynn Bendheim Thoman, Class of 1977, and Robert Bendheim, Class of 1937, Professor of Economics and Public Affairs at Princeton University. He is appointed jointly by the Department of Economics and the School of Public and International Affairs. Previously, he has held positions at the London School of Economics and the University of Copenhagen. He received his PhD from the University of Copenhagen in 2003. He has served as Co-Editor of the American Economic Review and Chief Editor of the Journal of Public Economics. He is a Fellow of the Econometric Society and a Research Associate at the NBER.

His research focuses on questions in public economics, labor economics, and inequality. This includes research on the effects and optimal design of public policies (such as tax policy, welfare, and family policy) as well as research on gender inequality in the labor market. His work has been published in the leading academic journals of economics. It is regularly cited in top media outlets, and it has influenced policy making in several countries.

You can read more about Henrik Kleven here

CEBI contact: Claus T. Kreiner.