Optimal Income Taxation: The Mathematics of Fairness and Efficiency

You wake on May 7, 2012, in Paris. François Hollande has just won the French presidency by 3.3 percentage points, and the campaign promise that electrified his base is now a governing obligation: a 75% marginal tax rate on all personal income above €1 million per year. Your job, as a senior economic advisor in the new administration, is to tell the President whether to do it.

The political logic is airtight. France's Gini coefficient had been creeping upward for a decade. The 2008 financial crisis had wiped out middle-class savings while leaving the fortunes of the CAC 40 executive class largely intact. Hollande had campaigned on the phrase "mon ennemi, c'est la finance" and the electorate had responded. The 75% rate applied to roughly 1,500 households. It was, by design, more symbol than revenue instrument.

But the economic logic is murkier, and that is your problem.

France's existing top marginal rate was already 41% on income above €70,830. Adding social charges pushed the effective top rate to around 50% before Hollande's proposal. The new 75% rate would apply only to the slice of income above €1 million, but the signal it sent was unmistakable: France was prepared to take three-quarters of a euro from every additional euro earned by its highest producers.

The equity argument is genuine. The top 1% of French earners captured a disproportionate share of income growth in the preceding decade. A 75% rate on millionaires would, in a static model, raise an estimated €200 to €300 million annually. Against a French budget deficit of roughly €87 billion in 2012, that is a rounding error. But redistribution is not only about the money collected; it is about the statement made and the norms reinforced.

You have one afternoon to prepare your recommendation. The question sitting on your desk is deceptively simple: will this tax raise the revenue and deliver the fairness it promises, or will it destroy the very base it is designed to tax?