Procedurally Fair Income Taxation Schemes

Abstract

We study the implications of procedural fairness on income taxation. All taxation schemes are allowed for, up to the constraints implied by incentive compatibility and budget balance. We formulate procedural fairness as a particular non-cooperative bargaining game and examine the stationary subgame perfect equilibria of the game. The equilibrium outcome is called tax equilibrium and is shown to be unique. Procedurally fair taxation schemes are defined as the taxation schemes that result in the limit of tax equilibria when the probability that negotiations break down converges to zero. The procedurally fair taxation scheme is shown to be unique. It is shown to correspond to the taxation scheme resulting from the Nash bargaining solution and leads to full redistribution of income.