Taxes versus Legal Rules as Instruments for Equity: A More Equitable View

Abstract:     
Most formal law and economic analysis evaluates legal rules solely on the basis of "efficiency." The prevailing justification for this focus is that -- as a matter of economic theory -- "equity" goals are best accomplished through the income tax, rather than the legal system. In opposition to that view, we argue that economic theory provides no reason to favor any one economic activity over another-leisure choice over care choice, for instance-in accomplishing redistributional goals. The optimal redistributional program will involve a mixture of methods and deviations from efficiency in one domain may even be used to correct inequalities arising in another.

In a modified version of the same model used to support the prevailing view, we find that: 1) even in the presence of an optimal income tax, any concern for equity dictates that legal rules should deviate from efficient standards in a manner that aids the less-well-off-this, so long as there is any heterogeneity in the way agents respond to the legal system; 2) when, in addition, income differences predominate in overall inequality, legal rules should in fact be adjusted away from efficient standards in a manner that helps low-income individuals; 3) under certain additional conditions, legal rules should be specifically adjusted to correct income-based inequality. Our results are at variance with those found in Shavell (1981) and Kaplow and Shavell (1994).

JEL Classifications: K00, K34, K13, H21, H23

Working Paper Series