Optimal Taxation with Rent-Seeking (2011)
<p><pre><code>  One might be tempted to expect a similar result to apply to the more general two
  sector model when only rent-seekers are the top earners. In fact, since the top earners
  are all rent-seekers, rent-seeking imposes a negative externality, and the government has
  a desire to redistribute from high-earners to low earners, this seems like a clear case for
  high marginal tax rates on high earners, as discussed in the introduction. As Theorem 4
  demonstrates, however, this intuition is not complete. The key reason is the additional
  sectoral shift effect not present in a one sector economy: By lowering the marginal tax
  rate on the top earning rent-seekers, total equivalent effort E increases and thus wages
  in the rent-seeking sector fall. As a consequence, some agents now find it profitable to
  leave the rent-seeking sector and become traditional workers. Since the traditional sector
  is socially more productive, this shift is always welfare enhancing (S &gt; 0)
</code></pre>
This took me a fair while to grok. So I think the point is that a Pigovian tax rate[0] is what you&#x27;d expect with a rent seeking sector and a non-rent seeking sector (trying to minimize the negative externalities of rent-seeking).<p>Now if we have nothing but rent seekers in the top income bracket and try and set their tax rate independently, you&#x27;d think that you should set it to the rate which is the value of the negative externalities that that sector produces, right?<p>The reason for the difference appears to be that in doing so, you make some of the people who would have been rent seekers switch from rent seekers to non-rent seeking behaviours, so to be pareto optimal, it &quot;costs less&quot; in taxes than the pigovian tax, because the logical thing decreases the &quot;attractiveness&quot; of being in the rent seeking sector, and the (logical) agents move to the socially benificial sector, thus producing an outsized effect of net good.<p>Is this right? can someone confirm whether I&#x27;m reading this correctly?<p>[EDIT] formatting<p>[0] <a href="https:&#x2F;&#x2F;en.wikipedia.org&#x2F;wiki&#x2F;Pigovian_tax" rel="nofollow">https:&#x2F;&#x2F;en.wikipedia.org&#x2F;wiki&#x2F;Pigovian_tax</a>