Optimal Redistributional Instruments in Tax Policy and Law & Economics: Survey and Assessment

Abstract

The literature on optimal redistributional instruments begins with the assumption that society has some preference for equality, leaving the precise degree unspecified. It then asks: How should society pursue that preference? More specifically, what kinds of policy instruments — whether categorized as “taxes,” “transfers,” “public goods,” “government programs,” “regulations,” or “legal rules” — should be informed by society’s distributional objectives? This paper reviews and assesses three strands of the literature on optimal redistributional instruments. The first concerns the “tax substitution argument,” which is offered in support of the proposition that distributional goals should generally be pursued exclusively through taxes on labor earnings. The argument, which is cast within the conventional optimal tax and policy framework, rests on an important additional assumption: very roughly, that controlling for labor earnings, all individuals are identical. The second subliterature examines the consequences of removing this additional assumption while retaining, arguendo, the optimal tax and policy framework. According to some researchers, that framework — shorn of the additional assumption — actually prescribes a strong form of “policy eclecticism” with regard to redistributional instruments. A third subliterature steps outside the bounds of the conventional optimal tax and policy framework to consider a kind of alternative defense of labor-income-tax exclusivity. Whatever the actual prescriptions of the conventional optimal tax and policy framework, the defense proceeds, policymakers lack adequate information about the proper direction and scale of distributionally motivated adjustments to other policy instruments. Critics argue that this defense neglects the comparable informational difficulties of labor earnings taxation and relies on a comparative “precautionary principle” that finds little support in systematic thinking about uncertainty and choice.