Personal Income Tax Decentralization, Inequality, and Social Welfare

Abstract

This article elaborates and evaluates a model for the decentralization of a personal income tax that is consistent with the optimal redistribution model. In this study’s model, the regions have individualistic, symmetrical, additively separable, and inequality-averse social welfare functions. Each region applies to its constituents a progressive personal income tax, which measures individuals’ ability to pay with sole regard to their income. The central government has a social welfare function, and its tax-raising power is limited to the establishment of a surcharge (or deduction) proportional to the income of individuals net of the respective regional taxes. This article presents the conditions that permit this model of fiscal decentralization to be recommended as a result of the reduction of inequality and the increase in welfare in each region and in the country as a whole. The theoretical results are applied to the Spanish income tax by the performance of various microsimulation exercises.