Optimal Labor Income Taxation: A Flexible Moral Hazard Approach

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ID: 313456
2026
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Abstract
Abstract This paper reconsiders the question of optimal labor income taxes for the very rich in the context of a flexible moral hazard (FMH) model. In this setting, risk is not exogenous. Rather, each agent can affect the probabilities of all possible income outcomes by allocating a fixed time endowment across a variety of distinct tasks. I prove that the optimal income tax rates on high-end earners and the optimal Pareto tail index of the pre-tax labor income distribution are both endogenously determined by agent preferences. In particular, a society with less risk-averse agents will find it optimal to impose a lower tax rate on the rich, even though its members’ choices give rise to a smaller Pareto right tail index. In contrast, this kind of negative co-movement between inequality and optimal tax rates is a suboptimal response in the classical Mirrlees (1971)-Diamond (1998)-Saez (2001) setup to changes in the exogenous distribution of skills.
Reference Key
openalex_W7161128453 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Narayana Kocherlakota
Journal The Review of Economic Studies
Year 2026
DOI
10.1093/restud/rdag046
URL
https://doi.org/10.1093/restud/rdag046
Keywords Keywords not found

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