Research in Progress

"Rent-Seeking and Optimal Taxation" (with Casey Rothschild)

Recent policy proposals have suggested taxing top incomes at very high rates, for instance through prohibitive bonus taxes in the financial sector. They are based on the argument that private returns to effort may greatly exceed the social marginal product of that effort. We examine this intuition in a model in which agents can choose between working in a traditional sector, where private and social marginal products coincide, and a rent-seeking sector. In the latter, some fraction of earned income reflects the capture of pre-existing output rather than increased production, and private returns decrease with the aggregate effort level. We characterize Pareto-optimal linear and non-linear income tax systems assuming that it is not possible to observe whether an individual is a traditional worker or a rent-seeker. Our main result is that, contrary to the above intuition, it can be optimal to subsidize top earners at the margin even if their social marginal product is zero. Intuitively, if top earners are very skilled rent-seekers, subsidizing their effort keeps private returns to rent-seeking low and thus reduces wasteful entry by other agents into rent-seeking activities.

"Quantitative Explorations of the Inverse Euler Equation in OLG-Economies" (with Emmanuel Farhi and Iván Werning)

We study the efficiency gains from distorting savings in private-information economies with overlapping generations. Extending the methods developed in Farhi and Werning (2009) to economies with life-cycle heterogeneity, we compute the efficiency gains from savings distortions by comparing an equilibrium where agents can save freely with a perturbed allocation that satisfies the Inverse Euler equation. We examine how these gains depend on the calibration of skill heterogeneity over the life cycle, contrasting the specifications by Storesletten et al. (2004) and Guvenen (2007). We also show how the efficiency gains can be bounded using aggregate consumption data over the life-cycle only. Preliminary computations suggest relatively modest gains for empirically realistic calibrations of OLG-economies. Moreover, most of the improvements can be attributed to the relaxation of borrowing constraints, rather than the introduction of savings distortions.