The Economic Efficiency of Progressive Taxation

Abstract

This paper suggests two mechanisms by which a progressive distribution of tax burdens may promote economic efficiency. First, a progressive tax rate structure indexed to the median income may discourage rent seeking by powerful interest groups. Second, progressive taxation favors income streams that are long-sustained over those that pay off over a shorter time span; this bias is likely to favor more socially productive activities. Consistent with these propositions, a marked retreat from progressivity for the top 0.1 percent of earners followed two decades of post-war economic expansion and preceded the productivity slowdown of the 1970s and the serial crises that have followed. The analysis suggests that progressivity is especially important at the top of the income distribution and that a top marginal rate that sets in too low — as would a single rate that applied to the top 0.1 percent of earners — would not achieve the right incentives.