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Tax Incidence In A Principal-Agent Framework

Tax Incidence in a Principal-Agent Framework∗
Francisco Rivadeneyra
June 17, 2005
Abstract
Using a Principal-Agent framework, this paper studies the implications
to economic incidence and behavioral changes of introducing a payroll
tax. Two kinds of comparative statics are performed, maintaining the
contract binding after the tax change and another that allows the contract
to change. The purpose is to derive a testable implication to measure the
incidence in this environment.
1 Introduction
Tax incidence studies the economic burden of a tax. The literature has had,
to some extent, an empirical approach. Most studies focus on accounting for
the effects of taxes over different cohorts of the population, between different
groups in the marketplace or effects over time to capital accumulation and the
like. For a review of the literature see Fullerton and Metcalf (2002).
The literature starts from the insight that, when lump sum taxes are not
available, agents respond to any kind of statutory tax by changing their behavior
to avoid the burden of it. The economic burden will depend on how prices change
for each agent as a response of taxes. Altought general, this insight assumes
that responses start from a simple equilibrium and are not constrained. But
what about a framework where agents cannot change their behavior as much as
they would in the sole presence of taxes? This is a very general question and can
embody a full set of models and situations. The purpose of this paper is draw
a parallel set of insigths to the traditional incidence literature in a setup where
agents cannot respond freely to a tax because their engagement in a contract
that restricts their decisions. This situation is a Principal-Agent framework for
the case of a employer-employee relationship.
Naturally, the contract restricts the set of choices, therefore suggesting two
types of comparative statics. The first were we maintain the pre-tax...