Elasticity determinants of inequality-reducing income taxation
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Elasticity determinants of inequality-reducing income taxation Oriol Carbonell-Nicolau1 · Humberto Llavador2 Received: 25 July 2018 / Accepted: 12 August 2020 / © Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract The link between income inequality and progressive taxation has long been considered a fundamental normative foundation for income tax progressivity. This paper furnishes necessary and sufficient conditions on primitives, in terms of the elasticity of income with respect to ability, under which various subclasses of progressive taxes are inequality reducing. The distributional effects of progressive income taxation are decomposed into two conditions on the wage elasticity of income, the tax rate effect and the subsidy effect, each capturing different aspects of the transition between before-tax and after-tax income distributions. The results confer a degree of useful flexibility to the theory, in that they allow the analyst to expand the universe of consumer preferences by suitably restricting the set of marginal-rate progressive taxes. As an illustration of the results’ practical implications, we provide a precise characterization of the subclass of (progressive) taxes that are inequality reducing for the constant elasticity of substitution (CES) and the quasi-linear utility functions. Keywords Incentive effects of taxation · Income inequality · Progressive taxation · Subsidy effect · Tax rate effect · Wage elasticity of income
1 Introduction The link between income inequality and progressive taxation uncovered in the seminal works of Jakobsson (1976) and Fellman (1976) has long been considered a fundamental
Electronic supplementary material The online version of this article (https://doi.org/10.1007/s10888-020-09461-8) contains supplementary material, which is available to authorized users. Humberto Llavador
[email protected] Oriol Carbonell-Nicolau [email protected] 1
Department of Economics, Rutgers University, 75 Hamilton St., New Brunswick, NJ 08901, USA
2
Department of Economics, Universitat Pompeu Fabra and Barcelona GSE, R. Trias Fargas 25–27, 08005 Barcelona, Spain
O. Carbonell-Nicolau, H. Llavador
normative foundation for income tax progressivity.1 In a recent paper, Carbonell-Nicolau and Llavador (2018) extended the classic result of Jakobsson (1976) and Fellman (1976)— according to which average-rate progressive, and only average-rate progressive income taxes, reduce income inequality—to the case of endogenous income. There it was shown that marginal-rate progressivity—in the sense of increasing marginal tax rates on income— is a necessary condition for tax structures to be inequality reducing, and necessary and sufficient conditions on preferences were identified under which progressive and only progressive taxes are inequality reducing. While this result circumvents the difficulties and the negative results emphasized by other authors in their attempts to incorporate the disincentive effects of taxation (see, e.g., Allingham (1979) an
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