Optimal Redistributional Instruments in Law and Economics

Abstract

This article discusses three strands of the literature on optimal redistributional instruments. The first strand concerns what is sometimes referred to as the ‘tax substitution argument’, which supports the proposition that distributional goals should generally be pursued exclusively through taxes (and subsidies) on labour earnings. The argument rests the controversial assumption that, controlling for labour earnings, all individuals are identical. The second strand, a response to the first, attempts to counter the view that labour earnings exclusivity for redistributional policy is the natural lesson of the economic literature on ‘optimal taxation’. This second subliterature examines the consequences of removing the tax substitution assumption while retaining, arguendo, the optimal tax and policy framework. The third strand of the literature, concerning ‘policy uncertainty’, steps outside the bounds of the conventional model of optimal tax and policy. It first arises as a kind of alternative defence of labour earnings exclusivity in light of the challenge posed by policy eclecticism. Even if the conventional optimal tax and policy model sans tax substitution assumption points toward eclecticism, the defence proceeds, policymakers lack adequate information about the proper direction and scale of distributionally motivated adjustments to other policy instruments. Given the risk of perverse unintended consequences, policymakers should refrain from distributionally motivated tinkering.