Benjamin B. Lockwood

Taxation and the Allocation of Talent

Taxation affects the allocation of talented individuals across industries by blunting material incentives and thus relatively magnifying the non-pecuniary benefits of pursuing a calling. If higher-paying industries (e.g. finance and management) generate less positive net externalities than lower-paying professions (e.g. public service and education) this may enhance efficiency. We develop a theory of income taxation as implicit Pigouvian taxation of these externalities and calibrate it using data on the distribution of income and talent across industries. Even without any redistributive motive, tax rates are highly sensitive to the externalities assumed within a spectrum many would consider reasonable: they range from extremely regressive to highly progressive at high incomes. Our theory thus offers an alternative, pure efficiency rationale for non-linear income taxation, challenging the connection between high long-run labor supply elasticities and low optimal tax rates and motivating further study of the externalities generated by professions.The efficiency consequences of taxation through its effect on occupational choice can be the opposite of the traditional labor supply effects that economists have focused on. Murphy et al. (1991) argue that some occupations may have positive, others negative, externalities. If occupations with positive externalities tend to be more enjoyable, then progressive taxation can have the efficiency benefit of encouraging talented, well-educated workers to go into more enjoyable, socially productive professions. I explore this mechanism and how social signalling, conformity, natural variation in the externalities of various professions and costly (rival) prestige can all play roles in generating it. I am working on gathering empirical data to test the effects of taxation on occupation choice. The argument suggests a number of directions for further research. This paper is the theory section of an ongoing project with an empirical component, and even this part is extremely preliminary and incomplete. ∗This paper was written while I was visiting at the Becker Center on Chicago Price Theory at the University of Chicago and I am grateful to the Center for their support. Ed Glaeser, James Heckman, Alex Kaufman, Steve Levitt, Kevin Murphy, Josh Schwartzstein, Jesse Shapiro, Andrei Shleifer and Heidi Williams provided helpful comments. As always, I am grateful most of all to my advisers Roland Benabou, Hyun Shin and especially Jose Scheinkman for their support and advice on this and other projects. †Bendheim Center for Finance, Department of Economics, Princeton University, 26 Prospect Avenue, Princeton, NJ 08540: eweyl@princeton.edu.