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Redistribution with Performance Pay

Nicolas Werquin, Pawel Doligalski and Abdoulaye Ndiaye

No 14648, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Half of the jobs in the U.S. feature pay-for-performance. We derive novel incidence and optimum formulas for the overall rate of tax progressivity and the top tax rates on total earnings and bonuses, when such labor contracts arise from moral hazard frictions within firms. Optimal taxes account for the fiscal externalities and welfare consequences of two distinct forces: a direct crowding-out of private insurance and a countervailing crowding-in due to endogenous labor effort responses. These imply that the amount of pre-tax earnings risk to which the worker is exposed is roughly invariant to tax progressivity, whereas the (adverse) welfare consequences of the crowd-out outweigh those of the crowd-in. Quantitatively, the optimal tax policy with performance-pay contracts is close to that prescribed by standard models that treat pre-tax earnings risk as exogenous. Finally, we uncover an efficiency-based argument for taxing bonuses at strictly lower rates than base earnings.Half of the jobs in the U.S.~feature pay-for-performance. We derive novel incidence and optimum formulas for the overall rate of tax progressivity and the top tax rates on total earnings and bonuses, when such labor contracts arise from moral hazard frictions within firms. Optimal taxes account for the fiscal externalities and welfare consequences of two distinct forces: a direct crowding-out of private insurance and a countervailing crowding-in due to endogenous labor effort responses. These imply that the amount of pre-tax earnings risk to which the worker is exposed is roughly invariant to tax progressivity, whereas the (adverse) welfare consequences of the crowd-out outweigh those of the crowd-in. Quantitatively, the optimal tax policy with performance-pay contracts is close to that prescribed by standard models that treat pre-tax earnings risk as exogenous. Finally, we uncover an efficiency-based argument for taxing bonuses at strictly lower rates than base earnings.

Keywords: Performance pay; Moral hazard; Endogenous wages; Optimal taxation; Social insurance; Bonus taxes (search for similar items in EconPapers)
JEL-codes: E62 H2 H3 J3 M52 (search for similar items in EconPapers)
Date: 2022-04
New Economics Papers: this item is included in nep-hrm, nep-ore and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Redistribution with Performance Pay (2023) Downloads
Working Paper: Redistribution with Performance Pay (2020) Downloads
Working Paper: Redistribution with Performance Pay (2020) Downloads
Working Paper: Redistribution with Performance Pay (2020) Downloads
Working Paper: Redistribution with Performance Pay (2020) Downloads
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