During this week's IMD Seminar Paweł Doligalski gave a talk presenting his research paper: Redistribution with performance pay. In the paper he and his co-authors Abdoulaye Ndiaye and Nicolas Werquin study the impact of the income tax on labor contracts that feature performance pay (e.g. a bonus for good performance), and how to tax such contracts optimally. The abstract of the paper is pasted below, but in a nutshell, in this paper we ask the question how to design income taxes on top earners when their earnings are partly composed of bonuses and if they should be treated separately from base earnings by the tax system.

Half of the jobs in the U.S. feature pay-for-performance. We derive novel incidence and optimum formulas for the overall rate of tax progressivity and the top tax rates on total earnings and bonuses, when such labor contracts arise from moral hazard frictions within firms. Optimal taxes account for the fiscal externalities and welfare consequences of two distinct forces: a direct crowding-out of private insurance and a countervailing crowding-in due to endogenous labor effort responses. These imply that the amount of pre-tax earnings risk to which the worker is exposed is roughly invariant to tax progressivity, whereas the (adverse) welfare consequences of the crowd-out outweigh those of the crowd-in. Quantitatively, the optimal tax policy with performance-pay contracts is close to that prescribed by standard models that treat pre-tax earnings risk as exogenous. Finally, we uncover an efficiency-based argument for taxing bonuses at strictly lower rates than base earnings.