Rational Majoritarian Taxation of the Rich: With Increasing Returns and Capital Accumulation

Abstract

In the United States political setting of 1993, the dominant majority coalition effectively excluded high income recipients (the rich) from participation in fiscal decisions and sought to increase the differentially high taxation of members of this group under a rhetoric of fair shares. This realworld fiscal environment motivates our analysis in this paper. We address the question: What rate of taxation should the political majority rationally impose on high-income recipients if this majority is motivated strictly in the interest of its members? We shall use highly abstracted models of the political economy that incorporate several simplifying assumptions. We suggest, however, that the results attained are relevant for the decision calculus of the leaders of the majority coalition. And in particular, we suggest that the possible presence of generalized or economy-wide increasing returns along with saving and the accumulation of capital make such decision calculus more difficult than that which would be implied in modern normative tax analysis that may involve maximization of a specific social welfare function. More specifically, our analysis indicates that the rational fiscal exploitation of the rich may involve lower tax extraction than orthodox fiscal theory would suggest. Or, in summary terms, the middle and low income members of the dominating majority may secure both more fiscal gains as well as non-fiscal benefits from the income-producing behavior of the rich than is recognized in the traditional analyses, and these benefits should be taken into account in any comprehensive reckoning. One implication involves the strengthening of the case for expenditure based taxation, even from the perspective of members of non-saving classes. We shall proceed as follows: we shall first, in section II, summarize the straightforward response to the question posed in a simple model that assumes all income is derived from current labor supply and that the economy operates under universalized constant returns. In section III, the constant returns assumption is replaced by one of generalized increasing returns. A central contribution in the paper is that of tracing out the effects of this change in the model. In sec-