Presented by Stern Economics, FAS Economics, and C.V. Starr Center for Applied Economics.
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This paper considers the taxation of top incomes when the following conditions apply: (i) new ideas drive economic growth, (ii) the reward for creating a successful innovation is a top income (though people can earn high incomes in other ways as well), and (iii) innovation cannot be perfectly targeted by a separate research subsidy — think about the business methods of Walmart, the creation of Uber, or the “idea” of Amazon.com. These conditions lead to a new force affecting the optimal top tax rate: by slowing the creation of the new ideas that drive aggregate GDP, top income taxation reduces everyone’s income, not just the income at the top. When the creation of ideas is the ultimate source of economic growth, this force sharply constrains both revenue-maximizing and welfare-maximizing top tax rates.