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Is Tax sharing Optimal? An Analysis in a Principal-Agent Framework

We study the effects of a statutory wage tax sharing rule in a principal - agent framework with moral hazard (à la Holmstrom, 1979) using the approach of Bose, Pal, Sappington (2007) to model the stochastic relationship between the agent’s unobserved effort and his observed performance. The analysis indicates that tax sharing with positive legislated contributions from both the employer and employee does not maximize any of the outcomes - employee effort, wages, profits or welfare. Moreover, a rule which specifies a corner solution, with 100% of the tax statutorily levied on the employer will maximize effort, expected profit and expected welfare while 100% of the tax statutorily levied on the employee will maximize expected wages.

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File URL: http://www.umbc.edu/economics/wpapers/wp_09_105.pdf
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Paper provided by UMBC Department of Economics in its series UMBC Economics Department Working Papers with number 09-105.

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Length: 5 pages
Date of creation: 20 Apr 2009
Date of revision:
Handle: RePEc:umb:econwp:09105
Contact details of provider: Postal: UMBC Department of Economics 1000 Hilltop Circle Baltimore MD 21250, USA
Phone: 410-455-2160
Fax: 410-455-1054
Web page: http://www.umbc.edu/economics

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  1. Debashis Pal & Arup Bose & David Sappington, 2007. "On the Performance of Linear Contracts," University of Cincinnati, Economics Working Papers Series 2007-05, University of Cincinnati, Department of Economics.
  2. Martin Feldstein, 1993. "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the1986 Tax Reform Act," NBER Working Papers 4496, National Bureau of Economic Research, Inc.
  3. Diamond, P., 1994. "Optimal Income Taxation: An Exemple with a U-Shaped Pattern of Optimal Marginal Tax Rates," Working papers 94-14, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Seade, J. K., 1977. "On the shape of optimal tax schedules," Journal of Public Economics, Elsevier, vol. 7(2), pages 203-235, April.
  5. David E. M. Sappington, 1991. "Incentives in Principal-Agent Relationships," Journal of Economic Perspectives, American Economic Association, vol. 5(2), pages 45-66, Spring.
  6. Eaton, Jonathan & Rosen, Harvey S., 1980. "Labor supply, uncertainty, and efficient taxation," Journal of Public Economics, Elsevier, vol. 14(3), pages 365-374, December.
  7. Feldstein, Martin, 1995. "Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Scholarly Articles 2766676, Harvard University Department of Economics.
  8. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  9. Eaton, Jonathan & Rosen, Harvey S, 1980. "Taxation, Human Capital, and Uncertainty," American Economic Review, American Economic Association, vol. 70(4), pages 705-15, September.
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