Progressive Income Tax and Comparative Advantage in Trade

Abstract

We show in the world trade data that countries with more progressive personal income tax system are less likely to have comparative advantage in industries that employ a greater share of high-income occupations, such as high-tech industries and professional services. Moreover, when countries increase their income tax progressiveness over time, they lose comparative advantage in sectors that use high-paying occupations intensively. We propose two theoretical mechanisms to explain these empirical observations: one is the occupational choice model based on the trade-off between the wage and leisure in the Heckscher-Ohlin framework; the other is the Heckscher-Ohlin model with international immigration of high income workers. Both models demonstrate that progressive income tax pushes workers away from high-income occupations and undermines the comparative advantage in industries that rely heavily on these occupations. Policy makers need to consider the side effect of income tax on industry competitiveness in the global market when fighting inequality.