This paper develops a model of taxation with asymmetric information be
tween the worker and the employer as well as between the worker and th
e tax collector. We show that if the informational asymmetry in the la
bour market is solved through signaling, implications for taxation are
strong. Taxing the signal directly, as well as imposing a progressive
tax on income, are both shown to have favourable welfare consequences
locally. In contrast to the results obtained for the progressive inco
me tax, we show that taxing the signal directly is likely to reduce ot
her distortions. The optimal tax fully exploits the possibilities to t
ax the signal directly before using progression.