Inequality Aversion, Externalities, and Pareto-Efficient Income taxation

Thomas Aronsson () and Olof Johansson-Stenman ()
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Thomas Aronsson: Department of Economics, Umeå School of Business and Economics, Postal: Umeå University, SE – 901 87 Umeå, Sweden.
Olof Johansson-Stenman: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: P.O. Box 640, SE 40530 GÖTEBORG, Sweden

No 785, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: This paper analyzes Pareto-efficient marginal income taxation taking into account externalities induced through individual inequality aversion, meaning that people have preferences for equality. In doing so, we distinguish between four different and widely used models of inequality aversion. The results show that empirically and experimentally quantified degrees of inequality aversion have potentially very strong implications for Pareto-efficient marginal income taxation. It also turns out that the type of inequality aversion (self-centered vs. non-self-centered), and the specific measures of inequality used, matter a great deal. For example, based on simulation results mimicking the disposable income distribution in the U.S., the preferences suggested by Fehr and Schmidt (1999) imply monotonically increasing marginal income taxes, with large negative marginal tax rates for low-income individuals and large positive marginal tax rates for high-income ones. In contrast, the in many respects comparable model by Bolton and Ockenfels (2000) implies close to zero marginal income tax rates for all.

Keywords: Keywords: Pareto-efficient taxation; Inequality aversion; Self-centered inequality aversion; Non-self-centered; inequality aversion; Fehr and Schmidt preferences; Bolton and Ockenfels preferences; GINI coefficient; Coefficient of variation (search for similar items in EconPapers)
JEL-codes: D03 D62 H23 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2020-05
New Economics Papers: this item is included in nep-ltv and nep-pub
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