Greg Mankiw's column in the New York Times makes the point that available evidence - in the US as well as Canada - suggests that high earners have higher labour supply elasticities than do workers lower down in the income distribution. As a result, increasing income tax rates on high earners would have disproportionately stronger effects on labour supply and total income. But there's one thing I don't understand in his analysis, and it's a point that never seems to be raised when the issue of taxing high earners is discussed: why would Greg Mankiw act as if the demand for his services were perfectly elastic?
But it's far from obvious to me that this sort of result can be extended to high earners. For example, if you find yourself in the market for Greg Mankiw's services, you quickly realise that there are very, very few good substitutes for Greg Mankiw. If he were to decide to increase his reservation wage in the face of a higher marginal tax rate rate, then many would-be employers would revise their offers accordingly. More generally, high earners operate in labour markets that are - almost by definition - fairly thin: with great salaries comes great market power. (See, for example, this anecdote.)
If high earners are able to offset higher taxes with higher gross incomes, then the force of some arguments is attenuated:
- As Alan Blinder notes here, inelastic demand elasticities shift the peak of the Laffer curve well to the right. Increased tax rates on high earners will almost certainly increase revenues.
- To the extent that market power partially offsets the increase in the effective marginal income tax rate, the efficiency losses predicted by optimal tax theory will be reduced.
- If high earners can deflect a significant portion of the incidence of the increased tax burden, then a tax on high incomes may not have the redistributional effects its proponents may have wished for (see also this post).
I'm unaware of any econometric evidence on the labour demand elasticities faced by high earners. Does anyone know of a study that could clarify matters?