Well-Being, Poverty, and Labor Income Taxation: Theory and Application to Europe and the United States

In a model where agents differ in wages and preferences over labor time–consumption bundles, we study labor income tax schemes that alleviate poverty. To avoid conflict with individual well-being, we require redistribution to take place between agents on both sides of the poverty line provided they have the same labor time. This requirement is combined with efficiency and robustness properties. Maximizing the resulting social preferences under incentive compatibility constraints yields the following evaluation criterion: tax schemes should minimize the labor time required to reach the poverty line. We apply this criterion to European countries and the United States. (JEL H23, H24, I31, I32, J22)

Optimal Income Taxation Theory and Principles of Fairness

The achievements and limitations of the classical theory of optimal labor-income taxation based on social welfare functions are now well known. Even though utilitarianism still dominates public economics, recent interest has arisen for broadening the normative approach and making room for fairness principles such as desert or responsibility. Fairness principles sometimes provide immediate recommendations about the relative weights to assign to various income ranges, but in general require a careful choice of utility representations embodying the relevant interpersonal comparisons. The main message of this paper is that the traditional tool of welfare economics, the social welfare function framework, is flexible enough to incorporate many approaches, from egalitarianism to libertarianism. ( JEL D63, H21, H24, J24)

Ramsey Strikes Back: Optimal Commodity Taxes and Redistribution in the Presence of Salience Effects

An influential result in modern optimal tax theory, the Atkinson and Stiglitz (1976) theorem, holds that for a broad class of utility functions, all redistribution should be carried out through labor income taxation, rather than differential taxes on commodities or capital. An important requirement for that result is that commodity taxes are known and fully salient when consumers make income-determining choices. This paper allows for the possibility consumers may be inattentive to (or unaware of) some commodity taxes when making choices about income. We show that commodity taxes are useful for redistribution in this setting. In fact, the optimal commodity taxes essentially follow the classic “many person Ramsey rule” (Diamond 1975), scaled by the degree of inattention. As a result, to the extent that commodity taxes are not (fully) salient, goods should be taxed when they are less elastically consumed, and when they are consumed primarily by richer consumers. We extend this result to the setting of corrective taxes, and show how non-salient corrective taxes should be adjusted for distributional reasons.

CREDIT FRICTIONS AND OPTIMAL LABOR-INCOME TAXATION

This paper studies optimal labor-income taxation in a simple model with credit constraints on firms. The labor-income tax rate and the shadow value on the credit constraint induce a wedge between the marginal product of labor and the marginal rate of substitution between labor and consumption. It is found that optimal policy prescribes a volatile path for the labor-income tax rate even in the presence of state-contingent debt and capital. In this respect, credit frictions are akin to a form of market incompleteness. Credit frictions break the equivalence between tax smoothing and wedge smoothing; therefore, as the tightness of the credit constraint varies over the business cycle, tax volatility is needed in order to counter this variation and, as a result, allow for wedge smoothing.

Taxation of Swedish Firm Owners: The Great Reversal from the 1970s to the 2010s

By the late 1960s, real effective taxation of income from individual firm ownership in Sweden approached 100 percent. A series of tax reforms has reversed this situation. This paper (1) elucidates the thinking behind the vision of creating a largely market-based system without wealthy capitalists and how that vision guided tax policy; (2) outlines and evaluates the changes in the tax code since the late 1970s, their empirical and intellectual basis, and their implications for the taxation of individual firm ownership; and (3) compares the size of the largest individual wealth holdings in the mid-1960s to their equivalents in the 2010s and discusses how the general public’s views have changed regarding sizeable income streams and wealth from business activity. Today, the tax code favors already wealthy individuals, while high labor income taxation combined with a high valuation of existing assets renders wealth accumulation difficult for persons with no initial wealth.

Social Ordering Functions

This chapter presents the fair social ordering approach to policy assessment. In an economic model, a social ordering function (SOF) associates each economy in the domain with a complete ranking of the allocations. This chapter describes the main achievements of the SOF theory. It presents two applications, which show how SOF’s can be used to evaluate policies. The first application concerns labor income taxation. The second application concerns the measurement of poverty. Finally, This chapter discusses the relationship between the SOF approach and some other approaches to the construction of criteria to evaluate policies.