Income Taxation of Privately Informed Agents by a Leviathan Government

Abstract

AbstractThis paper addresses how a Leviathan government taxes income if the earning potential is private information. This complements the normative analyses in the tradition of Mirrlees (1971). Taxes increase with respect to earning (potential and actual since taxation lowers observed earnings). However, accounting for the agent’s private information, average taxes (tax per income) decline for efficient types with zero marginal tax at the top. This conclusion is robust against alternative assumptions: a convex efficiency, i.e., high types are disproportionately more productive; an optimistic prior (i.e., high types are more likely), which, surprisingly, lowers the earnings of all types; and a government concerned about the welfare of its people.