Inequality as an externality: consequences for tax design

Morten Støstad and Frank Cowell

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Economic inequality may affect a wide range of societal outcomes, for example crime rates, economic growth, and political polarization. In this paper we discuss how to model such effects in welfarist frameworks. Our main suggestion is to treat economic inequality itself as an externality, which has wide-ranging implications for classical economic theory. We show this through the Mirrlees (1971) optimal non-linear income taxation model, where we focus on a post-tax income inequality externality. Optimal top marginal tax rates are particularly affected by the externality, implying a novel equality dimension to optimal top tax rate design. We propose that inequality's externality properties may have larger optimal top tax rate implications than standard revenue concerns; our model thus provides a theoretical basis for real-world governmental tax choices that seem irrational under standard optimal taxation models. We also show that the total inequality aversion implied by the current U.S. tax system is insufficient to accommodate both social welfare weights that are decreasing in income and a significant concern for inequality's externality effects.

Keywords: externalities; inequality; optimal income taxation; welfare (search for similar items in EconPapers)
JEL-codes: D62 H21 H23 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2024-07-01
New Economics Papers: this item is included in nep-mac, nep-pbe and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published in Journal of Public Economics, 1, July, 2024, 235. ISSN: 0047-2727

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http://eprints.lse.ac.uk/123752/ Open access version. (application/pdf)

Related works:
Journal Article: Inequality as an externality: Consequences for tax design (2024)
Working Paper: Inequality as an Externality: Consequences for Tax Design (2021)
Working Paper: Inequality as an Externality: Consequences for Tax Design (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:123752

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