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Envy, Inequity Aversion, and Optimal Income Taxation

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The paper analyzes the optimal income taxation policy when inequity aversion exists among taxpayers. The influence of inequity aversion on the optimal income tax scheme depends on whether taxpayers are concerned about inequality in wages or in rents (i.e., wages minus effort costs). If agents compare wages, then a more productive agent who is averse to inequity produces more output than the first-best level of output, while a less productive agent produces less than the second-best level of the output in a standard adverse-selection model. Therefore, the trade-off between efficiency and equity becomes more serious than the trade-off in a reference case without inequity aversion. Conversely, when agents' disutility from inequity arises from inequality in rents, the trade-off between efficiency and equity may become either more serious or milder than in the reference case.
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Keywords: ADVERSE SELECTION; INEQUITY AVERSION; REDISTRIBUTION; TRADE-OFF

Document Type: Research Article

Publication date: 2009-03-01

More about this publication?
  • As one of the world's oldest professional journals in public finance, founded in 1884, FinanzArchiv (FA) publishes original work from all fields of public economics which are of interest to an international readership, e.g. taxation, public debt, public goods, public choice, federalism, market failure, social policy, and the welfare state. Special emphasis is on high-quality theoretical and empirical papers on current policy issues.

    FA is a peer-reviewed journal commited to a prompt turnaround of submissions.

    FA is listed in the Social Science Citation Index (SSCI), in Current Contents/Social and Behavioral Sciences, in Econ Lit, in the Journal of Economic Literature, in IDEAS and RePEc and in the International Bibliography of the Social Sciences.

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