Today I'm presenting a paper at the meetings of the Canadian Economics Association: "Bargaining power and the incidence of taxes on high earners in Canada." The bottom line is that once you take into account the fact that high earners have bargaining power - that's why they are high earners in the first place! - then it's by no means clear that increasing the top marginal personal income tax rate will result in a progressive redistribution of after-tax income.
This is a theme I've been pursuing for years. From a post I wrote in November of 2009:
We can be pretty sure that if there's one group of people who won't be paying the tax, it is the high-income earners themselves - the reason for the increase in wages is to compensate them for the higher tax bill. And if we're talking about a small open economy whose capital markets are highly integrated with the rest of the world - and in the case of Canada, we are - then we also know that the tax will not be borne by owners of capital.
If neither high-income earners nor investors are paying those increased taxes, then they must be being taken from workers further down the income distribution. And as we move down the income distribution, workers' bargaining power diminishes: demand for labour becomes more elastic, and supply becomes less elastic. We could even have the perverse result of a tax on high incomes having regressive effects.
(Note also that imposing a wage cap just puts us back to being on the wrong side of the Laffer curve.)
So here are the possible outcomes:
- If wages don't adjust after the tax change, then we are very likely already on the wrong side of the Laffer curve for high-income earners: increasing the tax rates on high-income earners will reduce total revenues.
- If wages do adjust, the gross incomes of high-income will rise so that their after-tax incomes are the same. Extra revenues will be generated, but the burden of the tax increase will be borne by those below the top end of the income distribution.
The reality is likely to be more nuanced, but we can pretty much rule out the naive scenario in which there are no behavioural responses. And the existing literature suggests that those responses will generate effects that are almost exactly the opposite of the what we want to see happen.
See also this. At the time, and for several years after that, this was only a theoretical conjecture. But the recent deterioration of incomes and of top income shares at the very top of the Canadian income distribution provides an opportunity to identify high earner bargaining power, and that's what this paper tries to do.
Here's the abstract:
This study explores the 'brain drain' explanation for the concentration of incomes in Canada during the past thirty years, namely, that high-skilled Canadians have made use of the high salaries on offer in the United States to extract higher salaries at home. If this is the case, then for a given level of US salaries, the threat to accept outside offers should be more credible when the Canadian dollar is depreciating against the US dollar, and weaker when the Canadian dollar is appreciating. The data are broadly consistent with this claim: income concentration worsened during the depreciations of the 1980s and 1990s, and eased when the Canadian dollar began to appreciate in value.
The paper develops a simple two-parameter model based on the propositions that high earners in Canada can use US salaries to bargain for higher salaries, and that Canadian high earners can shelter part of their income from personal income taxes. It also offers some preliminary evidence about the parameter values consistent with available data. The results suggest that higher top marginal personal income tax rates may actually accentuate top-end after-tax income inequality. If high earners are able to use their bargaining power to extract pay increases to offset higher tax rates, the the burden of increased taxes will be pushed down to those lower down in the income distribution, leaving the after-tax income distribution more unequal than it was before.
This is still at the preliminary-draft please-do-not-cite stage; a more definitive version will be circulated in a few weeks. Comments are welcome.