Incentives, globalization, and redistribution

Abstract

We offer a new explanation for why taxes have become less redistributive in many countries while the concentration of incomes has increased. Our argument is based on the prevalence of incentive contracts in modern economies, in conjunction with increased product market integration. Globalization widens the spread of project returns and makes contract choices more responsive to tax changes. This can result in a lower optimal income tax rate while simultaneously increasing the income share of top earners. These results are confirmed in a calibrated version of our model based on U.S. income data.