Competing with precision: incentives for developing predictive biomarker tests

We study optimal income taxation in a two‐group framework where the private cost of misreporting income is positively correlated with productivity. If high‐wage types always reveal their income truthfully, letting low‐wage types cheat leads to Pareto‐superior outcomes regardless of the audit costs (as compared to deterrence). With no cheating, redistribution takes place on first‐ or second‐best frontiers and low‐wage types always end up worse off than high‐wage types. Letting low‐wage types misreport obviates the need to recourse to second‐best mechanisms. Additionally, it increases the reach of first‐best redistribution to outcomes at which low‐wage types are better off than high‐wage types.This article is protected by copyright. All rights reserved.