Optimal Policy with Heterogeneous Preferences

26 Pages Posted: 16 Jul 2008 Last revised: 21 Sep 2010

See all articles by Louis Kaplow

Louis Kaplow

Harvard Law School; National Bureau of Economic Research (NBER)

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Date Written: July 2008

Abstract

Optimal policy rules--including those regarding income taxation, commodity taxation, public goods, and externalities--are typically derived in models with homogeneous preferences. This article reconsiders many central results for the case in which preferences for commodities, public goods, and externalities are heterogeneous. When preference differences are observable, standard second-best results in basic settings are unaffected, except those for the optimal income tax. Optimal levels of income taxation may be higher, the same, or lower on types who derive more utility from various goods, depending on the nature of preference differences and the concavity of the social welfare function. When preference differences are unobservable, all policy rules may change. The determinants of even the direction of optimal rule adjustments are many and subtle.

Suggested Citation

Kaplow, Louis, Optimal Policy with Heterogeneous Preferences (July 2008). NBER Working Paper No. w14170, Available at SSRN: https://ssrn.com/abstract=1161093

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