The elite, inequality and the emergence of progressive taxation

Abstract

This paper explores theoretically the role of the ruling elites in the rise of progressive taxation in Western countries in the early 20th century. We focus on their interaction with the level of inequality between the elites and other citizens. We analyse a stylized political economy dynamic model where (wealthy) elite make a decision on the taxes to be paid by non-elite (poorer) citizens and by themselves. A fraction of citizens are fiscal-reciprocators: they experience positive (negative) reciprocity under a progressive (regressive) tax system. This proportion of citizens evolves over time according to their relative payoff compared to materialist citizens. We show that the choice of tax structure depends on the value for the elite of the public good generated by tax revenues, the proportion of fiscal-reciprocators and on the level of inequality between elite and citizen incomes. Our results show a dynamic complementarity between the level of reciprocity in society and tax progressivity. Indeed, this complementarity only operates if inequality is sufficiently low. In this case a progressive tax culture will be achieved, otherwise a regressive tax culture will prevail.