Working Paper 2018-462
The optimal income taxation literature focuses on the tradeoff between the equity gains of higher progressivity versus its greater incentive costs at the individual level. This paper highlights a neglected aspect of redistribution—greater progressivity requires a higher volume of gross redistributive flows, across income levels. If these flows are costly to manage, administratively or politically, then progressivity will be lower. Moreover if redistribution across income levels implies redistribution across socio-politically salient groups because of the way in which these groups line up relative to the income distribution, this can be an added cost in the objective function and progressivity is further disadvantaged. The paper develops a simple framework in which these questions can be addressed. Among the many interesting results is that when the capacity for the volume of redistributive flows, across income levels or across socio-political groups, is reached, an increase in market inequality can lead to a fall in progressivity in the tax-transfer regime without any change in the government’s preferences for equity. A focus on the volume of redistribution thus opens up an important set of theoretical and empirical questions for analysis and for policy.
Authors: Ravi Kanbur.