Keeping up with the Joneses, the Smiths and the Tanakas: On international tax coordination and social comparisons

Abstract

Recent evidence suggests that social comparisons between people in different countries have become more important over time due to globalization. This paper deals with optimal nonlinear income taxation in an international setting, where consumers derive utility from their relative consumption compared both with other domestic residents and people in another country. The optimal tax policy in our framework reflects both correction for positional externalities and redistributive aspects of such correction due to the incentive constraint facing each government. If the national governments behave as Nash competitors to each other, the resulting tax policy only internalizes the externalities that are due to within-country comparisons, whereas the tax policy chosen by the leader country in a Stackelberg game also to some extent reflects between-country comparisons. We also derive globally Pareto-efficient tax policies in a cooperative framework, and conclude that there are potentially large welfare gains of international tax policy coordination.