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<p>This note examines how optimal top-income tax prescriptions derived from modeling inequality as a negative externality depend on a maintained separability assumption that prevents inequality from influencing individual behavior. In a canonical inequality-externality formulation, the externality enters additively in the planner’s objective, so labor supply does not depend on the level of inequality, and the Pigouvian term can rationalize very high optimal top marginal tax rates. I show that introducing a minimal top-tail production margin, <i>endogenous entrepreneurship</i>, adds an additional sufficient statistic to the top-rate condition: the effect of the top wedge on entrepreneurial entry and aggregate output. When entrepreneurial activity generates social spillovers (for example, through innovation), this term can offset, or dominate, the welfare gain from compressing the post-tax distribution. An applied interpretation is provided by mapping the mechanism to the dilution-versus-insurance channel in the taxation-and-entrepreneurship literature. The message is that modeling inequality as an externality can support redistribution, but strong prescriptions for substantially higher top-income tax rates are not robust once top-tail production responses are allowed.</p>

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Inequality externalities and optimal top taxation with endogenous entrepreneurship

  • 期刊论文

  • 发表日期：

    2026年2月19日

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  • Niclas Berggren

摘要

This note examines how optimal top-income tax prescriptions derived from modeling inequality as a negative externality depend on a maintained separability assumption that prevents inequality from influencing individual behavior. In a canonical inequality-externality formulation, the externality enters additively in the planner’s objective, so labor supply does not depend on the level of inequality, and the Pigouvian term can rationalize very high optimal top marginal tax rates. I show that introducing a minimal top-tail production margin, endogenous entrepreneurship, adds an additional sufficient statistic to the top-rate condition: the effect of the top wedge on entrepreneurial entry and aggregate output. When entrepreneurial activity generates social spillovers (for example, through innovation), this term can offset, or dominate, the welfare gain from compressing the post-tax distribution. An applied interpretation is provided by mapping the mechanism to the dilution-versus-insurance channel in the taxation-and-entrepreneurship literature. The message is that modeling inequality as an externality can support redistribution, but strong prescriptions for substantially higher top-income tax rates are not robust once top-tail production responses are allowed.