Normative Measures of Tax Progressivity: an International Comparison

Abstract

The relevance of tax progressivity measures to policymaking depends on whether they help assess the extent to which taxation leads to social welfare gains or losses. The social welfare implications of progressivity measures have yet to be explored adequately in the literature. This paper helps to fill this gap by proposing a social welfare function framework to derive measures of tax progressivity and explore their normative properties. Using the social welfare framework, the paper derives the Kakwani index from Sen’s social welfare function as well as a new class of progressivity measures that incorporate a distributional judgment parameter capturing inequality aversion. The paper also discusses the social welfare implications of the Suits measure of tax progressivity and develops a new measure of tax progressivity derived from the Bonferroni social welfare function. The paper derives both relative and absolute measures of tax progressivity from the social welfare function framework. The methodology developed in the paper is applied to make international comparisons of tax progressivity in 32 developed countries. The paper calculates the magnitude of welfare gains and losses due to taxation and the required social rates of return of public investments for governments to break even. This paper finds that the governments in some countries have to generate high social rates of return from their public investments to compensate for losses of social welfare from taxation. It concludes that optimizing social welfare requires designing a progressive tax system, minimizing the administrative costs of collecting taxes, and maximizing the social rates of return by efficiently investing tax revenues.