Charity, Impure Altruism, and Marginal Redistributions of Income

Abstract

A conclusion of applied welfare economics is that marginal redistributions of income are inefficient [Browning and Johnson (1984), Ballard (1988)]. Yet, most of this literature ignores the fact that households can make tax-deductible gifts to private charity that alter the welfare cost of a reform. Welfare effects of marginal reforms are also altered if households are impure altruists [Andreoni (1989, 1990)]. A model for analyzing marginal reforms is developed that incorporates tax-deductible private charity and impure altruism. The model shows that a lump-sum transfer to the poor financed by a higher marginal tax on the rich will pass the Pareto test if households are pure altruists and charity is tax deductible. This holds unless initial marginal tax rates are high, the number of rich households is small, or the decline in labor supply is large. However, marginal redistributions of income are less likely to be efficient if households get a warm-glow from giving. Numerical calculations show how previous estimates of efficiency cost are altered if households are impure altruists.