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Taxes and the Efficiency‐Rent Extraction Trade‐off
Author(s) -
ARYA ANIL,
GLOVER JONATHAN,
MITTENDORF BRIAN
Publication year - 2006
Publication title -
journal of public economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.809
H-Index - 32
eISSN - 1467-9779
pISSN - 1097-3923
DOI - 10.1111/j.1467-9779.2006.00286.x
Subject(s) - economics , microeconomics , adverse selection , pareto principle , principal (computer security) , preference , operations management , computer science , operating system
This paper presents an adverse selection model in which progressive taxation enhances productive efficiency by encouraging a principal (buyer) to be less aggressive in contracting with an agent (seller). Wary of padded cost budgets, the buyer employs a hurdle‐rate procurement policy. With a low cost hurdle, the buyer keeps greater profits when transactions are undertaken but trade occurs less often. While the hurdle is unaffected by a flat tax, a progressive tax tilts the buyer's preference: the buyer's benefit from a lower hurdle becomes less pronounced, since the marginal increase in his profits is muted in after‐tax terms. The result is increased trade and the possibility of Pareto improvements.