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This raises a troubling question: if elite workers can protect their disposable income by extracting offsetting pay increases, then who is actually bearing the burden of the new tax? Or, in the language of public economics, what is the incidence of increased tax rates on high incomes?

An example from the U.K. illustrates the problem. When Gordon Brown introduced a 50 per cent tax on bonuses received by bank executives, financial institutions responded by doubling the size of their bonuses so that their employees’ net of tax income would remain unchanged by the new tax. The tax still generated revenue – indeed, the banks’ reaction meant that the government received twice as much as anticipated. But the burden of the tax was distributed among to the banks’ shareholders, their lower-ranked employees and their customers: that is, everybody except the ostensible target.

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If elite workers have enough bargaining power to shift the burden of the new tax to those lower down in the income distribution, an increase in the tax rates paid by high earners could produce an income distribution that is even more highly concentrated than it was before. If those at the top are able to maintain their after-tax incomes, then after-tax incomes further down must decrease. In this context, tax avoidance strategies may actually be a force for income inequality: they reduce the incentive to bargain harder for offsetting increases in pre-tax income, and they reduce the size of the tax burden that might otherwise be passed on to others.

The question of how much revenue will be generated by the new tax on high earners may turn out to be less important than the question of who ends up paying for it.

National Post

Stephen Gordon is a professor of economics at Laval University.