Relativity, Inequality, and Optimal Nonlinear Income Taxation

19 Pages Posted: 15 Nov 2013

See all articles by Ravi Kanbur

Ravi Kanbur

Cornell University; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Matti Tuomala

University of Tampere

Date Written: November 2013

Abstract

How does concern for consumption relative to others (“relativity”) affect the structure of optimal nonlinear income taxation? Our article provides three sets of answers to this general question. First, it supports the conclusion in the literature that relativity leads to higher marginal tax rates. In doing so, it both generalizes some of the conditions under which this result is obtained in the literature and fleshes out the detailed structure for optimal marginal tax rates for specific functional forms for distribution, utility function, and social welfare function. Second, the article goes beyond the literature and examines the impact of relativity on the progression of optimal marginal tax rates. By and large, we find support for greater progressivity, defined as the steepness of the rise of the marginal tax rate schedule, as relativity concern increases. Third, none of the papers in the literature, to our knowledge, examines the interplay of relativity and inequality in determining the optimal structure of income taxes. Our special analytical cases and more general numerical calculations support the conclusion that higher inequality dampens the positive impact of greater relativity on the level and the progression of marginal tax rates. More work is needed to further explore this interaction between relativity and inequality that our analysis has uncovered.

Suggested Citation

Kanbur, Ravi and Tuomala, Matti, Relativity, Inequality, and Optimal Nonlinear Income Taxation (November 2013). International Economic Review, Vol. 54, Issue 4, pp. 1199-1217, 2013. Available at SSRN: https://ssrn.com/abstract=2354709 or http://dx.doi.org/10.1111/iere.12033

Ravi Kanbur (Contact Author)

Cornell University ( email )

301-J Warren Hall
Ithaca, NY 14853
United States
607-255-7966 (Phone)
607-255-9984 (Fax)

HOME PAGE: http://www.kanbur.dyson.cornell.edu

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Matti Tuomala

University of Tampere ( email )

P.O. Box 607
Tampere, FIN-33101
Finland
+358-3-2156031 (Phone)
+358-3-2157254 (Fax)

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