Diversity Taxes: Linking Identity Expression, Social Contact, and Taxation

Abstract

The sociological literature suggests that within diverse communities, individuals create externalities on members of other social groups when they express identity through the consumption of market goods. Positive identity expression externalities lead individuals to increase their exposure to out-group identity expression, while negative externalities lead them to reduce it. At the same time, to the extent that identity expression is tied to market consumption, fiscal policy can influence how much identity is expressed by affecting individuals’ disposable income. We develop a theoretical framework in which identity expression externalities are addressed through these two channels: individuals privately adjust their social contacts to manage exposure, while local governments can use taxation to influence the visibility of identity in shared spaces. We study how these mechanisms interact, and how policy depends on which social group the government prioritizes and whether individuals react favorably or unfavorably to out-group expression. We find that governments amplify the behavioral response to diversity by adjusting the intensity of identity signaling through tax policy. We also show that greater openness to diversity can reduce demand for taxation, leading to more visible identity expression but also more private avoidance. The framework can accommodate a range of political-economy, fiscal, and institutional extensions.

Keywords: diversity, externalities, taxation, identity economics, social contact

JEL Classification: D62, Z18, H71, R51