Taxing Top Incomes

We model high income earners as sellers of quality services in a competitive assignment framework. Sellers (high income earners) are differentiated by ability; buyers by their taste for the service. There is assortative matching of buyers and sellers. We show that conventional optimal tax formulas are modified both by a social concern for buyers and an altered mapping of the talent into the income distribution. We quantitatively apply the model to the taxation of CEOs. We find that firm value and CEO income data is consistent with a talent distribution that has a thin tail and bounded support and, given sufficient concern for non-CEO firm claimants very low and, perhaps, zero optimal marginal tax on top incomes. (JEL D31, H21, H24, M12, M52) *Ales: [email protected] Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213; Sleet: [email protected]. Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213.