HORIZONTAL INEQUALITY IN OPTIMALTAXATION: EVIDENCE FROM A DEVELOPMENT CONTEXT

Magnus Eldrup
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Magnus Eldrup: Department of Economics, University of Copenhagen

No 26-18, CEBI working paper series from University of Copenhagen. Department of Economics. The Center for Economic Behavior and Inequality (CEBI)

Abstract: Exemptions are a key feature of income tax systems in developing countries, yet standard optimal tax models cannot explain them. By assuming full compliance, these models ignore horizontal inequality between formal and informal workers, understating the social cost of taxing the former. Extending the optimal tax framework, I incorporate informality and horizontal inequality aversion. I conduct a survey experiment in Kenya, finding that respondents place substantially higher welfare weight on formal taxpayers than otherwise identical informal workers. Combining these empirical preferences with administrative tax data yields prescriptions of high exemption thresholds matching observed policy, a result alternative explanations cannot rationalize.

JEL-codes: C93 D63 H21 H26 O17 (search for similar items in EconPapers)
Pages: 71
Date: 2026-09-25
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