TY - JOUR AU - Piketty,Thomas AU - Saez,Emmanuel AU - Stantcheva,Stefanie TI - Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities JF - National Bureau of Economic Research Working Paper Series VL - No. 17616 PY - 2011 Y2 - November 2011 UR - http://www.nber.org/papers/w17616 L1 - http://www.nber.org/papers/w17616.pdf N1 - Author contact info: Thomas Piketty Paris School of Economics 48 Boulevard Jourdan 75014 Paris, France E-Mail: piketty@ens.fr Emmanuel Saez Department of Economics University of California, Berkeley 530 Evans Hall #3880 Berkeley, CA 94720 Tel: 510/642-4631 Fax: 510/642-6615 E-Mail: saez@econ.berkeley.edu Stefanie Stantcheva MIT Department of Economics 50 Memorial Drive Building E52 Cambridge, MA 02142-1347 E-Mail: stefanie@mit.edu AB - This paper presents a model of optimal labor income taxation where top incomes respond to marginal tax rates through three channels: (1) standard labor supply, (2) tax avoidance, (3) compensation bargaining. We derive the optimal top tax rate formula as a function of the three corresponding behavioral elasticities. The first elasticity (labor supply) is the sole real factor limiting optimal top tax rates. The optimal tax system should be designed to minimize the second elasticity (avoidance) through tax enforcement and tax neutrality across income forms. The optimal top tax rate increases with the third elasticity (bargaining) as bargaining efforts are zero-sum in aggregate. We provide evidence using cross-country times series macro-evidence and CEO pay micro-evidence. The macro-evidence from 18 OECD countries shows that there is a strong negative correlation between top tax rates and top 1% income shares since 1960, implying that the overall elasticity is large. However, top income share increases have not translated into higher economic growth. US CEO pay evidence shows that pay for luck is quantitatively more important when top tax rates are low. International CEO pay evidence shows that CEO pay is strongly negatively correlated with top tax rates even controlling for rm characteristics and performance, and this correlation is stronger in firms with poor governance. These results are consistent with bargaining effects playing a role in the link between top incomes and top tax rates. If bargaining effects in fact exist, optimal tax rates should be higher than commonly assumed. ER -